Market surveillance: Lower interest rates – should we complain?

COMMENT:

The Reserve Bank of New Zealand following the US Federal Reserve to move away from rate hikes, stock market investors have good reason to rejoice.

Interest rates seem to remain low longer, which has favored a strong market rebound.

The NZX-50 hit new highs after the Reserve Bank statement Wednesday and it has now risen more than 10% over the course of the year.

But lower rates also have a negative impact on the markets, said Pie Funds general manager Mike Taylor.

Last week, Wall Street was shaken and strongly plunged into the announcement of the reversal of the Treasury yield curve, a sign that usually indicates an impending recession.

In short, interest rates, already low, should stay longer and even possibly fall further.

While this should be broadly good news for the equity markets, the recent Wall Street reaction shows that it has hardly inspired confidence in the global economy.

Last week, the yield on the 10-year US Treasury bill fell below the three-year note rate.

This means that bond investors are better paid for holding short-term US government debt than for long-term debt – a sign of pessimism for the economic future.

"Why is it important for the markets, it's because the yield curve has been predicting every recession since the Second World War," Taylor said.

However, based on past experience, the process could still take some time.

There was an old adage of investment whereby the bond market was smarter than the stock market, Taylor said.

But history has suggested that a recession could take up to two more years to emerge.

In that sense, it should not be a cause for panic, he said.

The economic expansion of the United States is already at an advanced stage and, if it takes effect until the end of June, will be the longest in the history of this country.

One of the big differences this time around is that central banks have been much more proactive, Taylor said.

"In previous cycles, central banks have tried to control inflation and have quickly raised rates," he said.

The key for investors would remain focused on the data, Taylor said.

But what the data showed was that the world economy was slowing down.

"The number of manufacturers around the world is slowing, earnings growth is slowing down, and central banks are doing this for a reason of their own – they are not doing it just to be nice to investors."

Central bank action now has the potential to lead to a more gradual slowdown than in the past, Taylor said.

This kind of scenario would probably mean more volatility in the markets but would avoid at least one major crash.

Investors will have to keep an eye on actual gains and valuations, he said.

But lower rates would likely involve more money returning to the markets.

"Global pension funds have target rates of between seven and a half percent and they will not get US Treasuries out of New Zealand government bonds."