Interest Rate Rises would threaten a crash in every asset
The Unhived Mind [UHM]
‘Rate rises threaten crash in every asset’
The value of almost all investments, including shares, bonds and property, could fall if investors believe that interest rates are about to return to normal, a senior fund manager has warned.
Richard Evans By Richard Evans, Investment Editor5:57PM BST 06 Aug 2013CommentsComments
Ben Inker, the co-head of asset allocation at GMO, a giant American asset manager, said the US Federal Reserve’s policy of low interest rates had boosted the value of almost all assets and that any expectation that rates would rise risked triggering a reversal.
When returns on cash are low, investors switch to other assets in the search for higher income. This increased demand pushes up prices.
“By pulling down both today’s cash [interest] rate and the market expectation of future cash rates, the Fed has increased the relative attractiveness of pretty much all assets other than cash and, as a consequence, their prices have risen,” Mr Inker wrote in a recent research note.
“Since 2009 it has been difficult to avoid making money in the financial markets. Conventional bonds, inflation-linked bonds, commodities, credit, equities, real estate – everything – has been bid up as a consequence of the very low expected returns of cash.”
But he warned that this gave today’s markets “a vulnerability that has not existed through most of history”.
“Today’s valuations only make sense in light of low expected cash rates. Remove that expectation, and pretty much every asset across the board is vulnerable to a fall in price, as the rising real discount rate plays no favourites,” Mr Inker said.
He added: “We have known this for a while, but the trouble is that there is no easy way to resolve this problem. There is no asset class you can hold that would be expected to do well if the real discount rate rises from here.”
Under normal circumstances, rising rates would follow rising inflation or stronger than expected growth, which a diversified portfolio of investments could usually cope with, he said.
But recent fears of rate rises came not because inflation was unexpectedly high, or because growth will be so strong as to lift earnings expectations for equities and other owners of real assets, but “because the Fed signalled that there was likely to be an end to financial repression in the next few years”.
“Financial repression” means artificially low real (inflation-adjusted) interest rates imposed by governments as a means to reduce their own borrowing costs.
The effects of a change of direction are unlikely to be confined to America.
Mr Inker added: “Because financial repression has pushed up the prices of assets across the board and around the world, there is unlikely to be a safe harbour from the fallout, other than cash itself.
The new Governor of the Bank of England, Mark Carney, is expected to outline his approach to guiding the market about future interest rate changes tomorrow. Money market rates are pricing in the possibility of the first move in the Bank Rate, currently 0.5pc, in three years.
What can investors do to protect themselves?
Mr Inker said their was no certain way of avoiding losses – holding cash would pay good returns if interest rates returned to normal quickly, say within two years, but would lose investors money to inflation if the process took longer, such as seven years.
He used a summer camp metaphor to explain his approach to dealing with the problem.
“We’re in a canoe race to the other side of the lake. We know all of the canoes are old and a bit leaky in the best of times, and there’s a storm coming. If we knew the storm were going to break now, we’d just stay in the cabin and laugh at everyone else as they were forced to turn around and trudge back to the cabin, sopping wet and half drowned.
“But we don’t know when the storm will break or even if it might miss us altogether, so we’ve stuck an extra guy in the middle of our boat with a bucket instead of a paddle. We know it will slow us down, but it will go a long way to help ensure we don’t sink along the way, even if we’re resigned to the likelihood of a long slow paddle in the rain, sitting in water up to our ankles.
theunhivedmind says:
If interests rate start to rise, straight away we will enter a complete economic collapse. Why? The derivatives market! May I remind you the Federal Reserve is sucked under a 10000:1 ratio of derivatives to supposed reality. Back three to four years ago the derivatives market was $1.4 quadrillion so imagine how big it is today. When The Worshipful Company of Mercers are ready to pull the plug on the economy they will raise interest rates and take over everything they have enslaved to their debt creation agenda previously. I believe the Mercers will destroy the economy in 2017 and I still believe this. If we look at Mark Carny’s Forward Guidance he hints at interest rates staying the same as the Bank of England for possibly the next three years.
-= The Unhived Mind