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19-08-2015, 11:02 PM
OPINION Aug 19 2015 at 5:16 PM Updated Aug 19 2015 at 6:27 PM
Rates to stay lower for longer says Obama adviser
There is more to low rates than government policies. James Davies
Philip Baker
The prospect of rising interest rates in the United States has got many investors worried but The Council of Economic Advisers, the Washington based agency that offers advice to President Obama, has issued a report that suggests in the long run, interest rates will always be lower when compared to where they were before the financial crisis took hold.
Interest rates around the world have been falling since 1982 so investors have certainly got used to the benefits of cheap money.
But not everyone thinks they will stay at these historically low levels.
The former chairman of the Federal Reserve, Ben Bernanke, argues that rates are at record lows thanks to government policies that have forced everyone to save.
His tip is once these policies are reversed then interest rates will rise back to more normal levels.
Not so fast, according to Larry Summers, the former Treasury Secretary.
He believes rates are low because there is no "demand" in the US economy and under a theory of his called "secular stagnation" he argues that prolonged low interest rates are here to stay unless the government starts spending up big-time again on infrastructure projects.
As for the CEA they believe that some of the drivers that have kept rates so low, such as shifting demographics and lower long-run growth and productivity rates will keep them low for quite some time yet.
But the other drivers that have also kept rates low, such as fiscal, monetary and exchange rate policies along with inflation risk, term premium and private-sector deleveraging will be shortlived factors.
In the end though they claim that once all the factors are taken into account, it "suggests that long-term interest rates will be lower in the long run compared with their levels before the financial crisis."
In 2007 the benchmark US 10-year government bond yield was around 4.25 per cent compared to 2.18 per cent on Wednesday, while in Australia the 10-year bond yield was just over 6 per cent eight years ago before the crisis, compared to 2.74 per cent.
Falling interest rates and lower bond yields have been a key driver behind any gains in the sharemarket, despite a lack of earnings.
The accompanying graph shows the fall in the market's forward earnings yield, which is the inverse of the forward price-earnings ratio, has coincided with a fall in the 10-year government bond yields.
The main point about the analysis is the comparison of the yield on a 10-year government bond to the "earnings yield" of the sharemarket.
The earnings yield is the flipside of the price-earnings multiple, so instead of dividing the P by the E, the E is divided by the P.
It shows the amount of earnings you buy for every dollar worth of stock.
The forward earnings yield of the major S&P ASX 200 index is around 6.3 per cent, while the 10-year bond yield is close to 2.74 per cent – implying an earnings to bond yield differential of 3.56 per cent, which is well above the longer-run average differential of 2.5 per cent.
One oft-cited reason for further gains by those in the bullish camp is that stocks represent better value than a bond market investment.
Compared with the 10-year bond yield of 2.74 per cent, stocks appear more attractive.
Rates to stay lower for longer says Obama adviser
There is more to low rates than government policies. James Davies
Philip Baker
The prospect of rising interest rates in the United States has got many investors worried but The Council of Economic Advisers, the Washington based agency that offers advice to President Obama, has issued a report that suggests in the long run, interest rates will always be lower when compared to where they were before the financial crisis took hold.
Interest rates around the world have been falling since 1982 so investors have certainly got used to the benefits of cheap money.
But not everyone thinks they will stay at these historically low levels.
The former chairman of the Federal Reserve, Ben Bernanke, argues that rates are at record lows thanks to government policies that have forced everyone to save.
His tip is once these policies are reversed then interest rates will rise back to more normal levels.
Not so fast, according to Larry Summers, the former Treasury Secretary.
He believes rates are low because there is no "demand" in the US economy and under a theory of his called "secular stagnation" he argues that prolonged low interest rates are here to stay unless the government starts spending up big-time again on infrastructure projects.
As for the CEA they believe that some of the drivers that have kept rates so low, such as shifting demographics and lower long-run growth and productivity rates will keep them low for quite some time yet.
But the other drivers that have also kept rates low, such as fiscal, monetary and exchange rate policies along with inflation risk, term premium and private-sector deleveraging will be shortlived factors.
In the end though they claim that once all the factors are taken into account, it "suggests that long-term interest rates will be lower in the long run compared with their levels before the financial crisis."
In 2007 the benchmark US 10-year government bond yield was around 4.25 per cent compared to 2.18 per cent on Wednesday, while in Australia the 10-year bond yield was just over 6 per cent eight years ago before the crisis, compared to 2.74 per cent.
Falling interest rates and lower bond yields have been a key driver behind any gains in the sharemarket, despite a lack of earnings.
The accompanying graph shows the fall in the market's forward earnings yield, which is the inverse of the forward price-earnings ratio, has coincided with a fall in the 10-year government bond yields.
The main point about the analysis is the comparison of the yield on a 10-year government bond to the "earnings yield" of the sharemarket.
The earnings yield is the flipside of the price-earnings multiple, so instead of dividing the P by the E, the E is divided by the P.
It shows the amount of earnings you buy for every dollar worth of stock.
The forward earnings yield of the major S&P ASX 200 index is around 6.3 per cent, while the 10-year bond yield is close to 2.74 per cent – implying an earnings to bond yield differential of 3.56 per cent, which is well above the longer-run average differential of 2.5 per cent.
One oft-cited reason for further gains by those in the bullish camp is that stocks represent better value than a bond market investment.
Compared with the 10-year bond yield of 2.74 per cent, stocks appear more attractive.