E Zero Rates And Equities

“U.S. interest rates will stay near zero for at least three years as the Federal Reserve enacts measures to prop up the economy. But are low-interest rates a new phenomenon? Interestingly, one study by the Bank of England shows that this pattern of declining interest rates has taken place globally since the late Middle Ages. In fact, it suggests that these downward-sloping rate trends have taken place even before modern central banks entered the scene—illustrating an entrenched, historical trend.” (Dorothy Neufeld, October 1, 2020)

In a world of zero policy interest rates, long-term bonds have been providing the only action available to fixed income traders.

The conventional wisdom is that investors are betting on steeper yield curves partly because they expect inflation pick up due to the major monetary and fiscal policy boosts which have been given to virtually all advanced economies because of the pandemic recession.

Economic theory and historical data also suggest that low-interest rates bolster stock prices in the short term, and there may even be secondary or hidden catalysts that provide for longer-term favorable impacts. On the other hand, given the crap-shoot nature of financial markets, zero interest rates also could trigger a catastrophic inflationary outcome.

Nonetheless, as long as the zero-policy interest rate environment continues, the search for higher yields will remain, and of course, this should boost equity markets.

The most important interest rate for the stock market is the US Fed’s benchmark rate, the federal funds rate. The federal funds rate is the rate commercial banks are charged for borrowing money from Federal Reserve banks.

And the Fed has signaled on many occasions that the federal funds rate will remain near zero at least through until the end of 2022.

Indeed, virtually all of the important central banks are similarly expected to keep the stimulus pedal to the metal in 2021 and 2022.

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William K. 3 weeks ago Member's comment

Quite interesting, and it brings up points that I had not considered.