Since the 2008 financial crisis, very low interest rates around the world, including in the four largest developed economies of Japan, Europe, China and the United States have been the “new normal.”

A zero interest rate policy – known as ZIRP – has been the pervasive approach of central banks, including the Fed, as they looked to bring back the growth of the post WWII to early 2000s era. In the past year, ZIRP turned to NIRP – negative interest rate policy – in a handful of nations as growth has been hard to find and economic risks returned.

BREXIT Impact on Rates

In the weeks leading up to the U.K. vote on whether or not to stay in the European Union, interest rates fell on the fear of a U.K. vote to leave. That fear led to a “flight to safety” by investors who sold riskier assets and bought assets they perceived as safer. Among the impacted assets were the German bund, U.S. Treasuries and the Japanese Yen.

In the case of Germany’s 10-year government bund – Europe’s benchmark bond – it’s interest rate has fallen below zero percent for the first time ever – joining the ranks of NIRP. Germany has now joined Switzerland and Japan as having negative yields on their 10-year bonds. That means investors are loaning the German (and Swiss and Japanese) government money in return for less money back later – I’ll give you two hamburgers today for one next Tuesday.

With the U.K. now poised to leave the EU, European Central Bank President Mario Draghi has pledged to protect the banking system’s liquidity with further stimulus measures which are also meant to help the EU economy weather any Brexit induced storm.

Most observers expect the EU stimulus by September. These actions are likely to force interest rates down even further in the region, including Switzerland who does not use the Euro. However, most economists do not expect much impact on European growth rates as it appears monetary stimulus measures are running out of effectiveness.

China also reacted to the fallout of Brexit by devaluing the Yuan peg to the dollar by the most since last year. With China still struggling to convert to a consumer led economy and reliant on trade exports it is not unlikely that the People’s Bank of China (PBOC) continues to adjust rates in order to maintain competitiveness.

This unprecedented series of events has been cited by Bill Gross of Janus Funds and Jeffrey Gundlach of Doubleline Capital, the past and current “bond kings” in the mutual fund world, as presenting enormous risks.

Gundlach stated that “Central banks are losing control and they don’t know what to do.” Gross, in a tweet to investors stated that “Global yields are the lowest in 500 years of recorded history. (There is) $10 trillion of negative (interest) rate bonds. This is a supernova that will explode one day.”

Janet Yellen Acknowledges Structural Economic Challenges

On top of Brexit and general economic risks, Federal Reserve Chair Janet Yellen, for the first time, recently acknowledged that the global economy could be facing long-term secular forces which result in slow growth for an extended period. A pathetic jobs report last month that missed economist expectations by over half, no doubt played a role in her statements.

The result of Yellen’s revelation was that the Fed did not raise interest rates – as we have expected and discussed on the radio – as well as, also reduced expectations for further interest rate increases over the next few years – another thought we have discussed.

On the chart below, you can see how Federal Reserve member expectations of future interest rate increases have changed recently in response to global economic risks and realities.
Prior to her recent Fed minutes speech, Yellen had repeatedly alluded to the after effects of the financial crisis as being the main headwind to accelerating economic growth. Now, she is acknowledging issues that we have also pointed to, such as slowing productivity, aging demographics and massive global debts, as being structural and longer-lasting in nature, saying that these are “factors that are not going to be rapidly disappearing, but will be part of the new normal.”

Whether this was a burst of candor or a new set of revelations for Yellen isn’t important to us. What was nice though, was that we got an honest, realistic and plain spoken assessment of what the Fed is seeing and thinking. For too long we have been left guessing what the Fed might or might not do. Now, we know that their expectation is that low interest rates are likely here to stay for quite a while.


*This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the readers as research or investment advice nor should it be construed as a recommendation to purchase or sell a security.

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