We are entering the time of year where investment strategists are starting to pen their explanations about why 2014 has turned out to be a pretty interesting year, and to speculate on the likely returns investors can expect for 2015.
The outlook sections that have passed over my desk appear to have established a consensus that 2015 will see little change in developed world interest rates. This is captured by the phrase ‘lower for longer’.
If you have the same internet search habits as me, the first story Google presents to you when you enter this phrase features Janet Yellen of the Federal Reserve commenting that unemployment needs to fall before her institution should consider raising interest rates.
In the story, Ms Yellen is referred to as the vice chairman and reported unemployment is above 6.5 per cent, whereas now she is the chairman and the unemployment rate is 5.8 per cent.
Closer inspection reveals this is an old article from April 16 2013. The point I am making is that lower for longer is not a new phrase. The UK cut its interest rates to 0.5 per cent back in March 2009, so lower for longer has indeed been correct, but is that a fact of history or a valid forecast for 2015?
I am very fortunate to have access to Bloomberg, which is an ideal tool for delving into all sorts of financial data.
Something that caught my eye recently was that the database has UK base-rate data going back to 1911. So it is easy to observe how this has moved through world wars, depression, stagflation, the great moderation and the financial crisis.
Most observers refer to the financial crisis as the worst market/economic calamity since the 1930s’ depression, so one would expect that monetary policy was more accommodative then, given that the environment was judged to have been worse.
However, that would be wrong as interest rates remained at 2 per cent, not 0.5 per cent as they are today.
Lower for longer might have been a refrain from that period too. Rates were held at 2 per cent for seven years from June 1932 to June 1939 before briefly rising to 3 per cent as war broke out across Europe.
They were then reduced to 2 per cent again until 1951. I’m not sure we can compare today’s environment with that period. Back in the 1930s, unemployment was roughly 25 per cent, whereas now it is 6 per cent. Although many would say they have not felt the benefit of the UK recovery, we must all agree we are not in a depression, especially as UK GDP has grown by 3 per cent in the past 12 months.
We suspect the likely pathway of interest rates will be higher and quicker than the market is anticipating, which clearly puts us in the minority.
The Bank of England had mooted raising rates, but now appears to not wish to interfere with the UK election in May so will delay, falling further ‘behind the curve’.
Subsequent rate rises may be quicker as a result. In the US, the Federal Reserve is clearly communicating that the market is being too conservative, using its ‘dot plots’ to show they expect to have raised rates by end 2015 to 1.375 per cent (from 0.25 per cent) whereas the market is pricing 0.63 per cent.
This view is clearly not bullish for the bond market.
Marcus Brookes is head of multi-manager at Schroders
