Market news | 28 September, 2017

The expected trend in benchmark rates

Alberto Villasán Investment and Markets Director

At the end of 2015, the US Federal Reserve began official rate hikes at a much slower pace than on other occasions and with no apparent reasons for doing so, because neither inflation nor economic growth had passed thresholds for concern.

Inflation, specifically, has remained on average at around 1.3%, well below its past mean and the 2% target of the US central bank. Meanwhile, the economy is growing at a pace below that of the last 40 years.

Interest rates at around 0% for seven years from 2008 to 2015 led many investors to take the plunge and buy risk assets (stock market and corporate bonds in particular) and companies to borrow to hitherto unseen levels, capitalising on the low financing costs.

This situation has fostered one of the biggest asset valuation bubbles of all time and we think it is the main reason why the Federal Reserve has begun to gradually raise benchmark interest rates, i.e., to revert this situation.

The debt levels of most countries are at all-time highs and this makes their economies more sensitive than ever to rate hikes, therefore it is more than likely that the hikes being implemented by the US monetary authorities will be limited to around 2% and they could foster a new recession which, in the end, would imply another cut in rates back to 0%.

Benchmark rates affects both our investment style…

 

These movements in rates, at levels approaching 0% for seven years and now climbing freely, have a decisive effect on the way in which investors appraise assets, make investments and, in the last instance, perceive risks.

Hence, many financial analysts are saying that assets could come to have any price in a low (interest) rate environment like the present. Low rates also imply lower economic growth and thus limited asset valuations.

Low rates also imply lower economic growth and thus limited asset valuations. We can see a clear example of this in Japan, where, although official rates have remained at 0% for years, this has not led to uptrends on its stock markets.

… and our financing style.

Low benchmark rates are also affecting the way in which companies fund their activities.  The latest rate hikes in the USA are encouraging the idea that it is better to attain financing at a fixed as opposed to a floating rate. Although we may see further hikes over the coming months, rates are likely to return to around 0% in 2 to 3 years’ time.