Low interest rates:
is the end in sight?
The Federal Reserve has announced a programme for the reduction
of its balance sheet, and a potential normalisation of global short-term
rates looks closer to becoming a market reality, as Andrew Baron of
Butterfield Asset Management explains.
54 cayman captive 2018
in the US, around the world, negative short-term interest rates remain
a feature to this day in the eurozone, Switzerland, Japan, Sweden
In most of these places, discussion of raising rates to zero has barely
even begun, much less a contemplation of positive rates. In addition to
setting rates at very low or negative levels, itself an experiment rarely
attempted in the history of modern central banking, global central banks
also embarked on another method of injecting money into the monetary
system called quantitative easing (QE). QE is a simple concept, if highly
experimental and previously unprecedented, and in practice is just the
process of buying low-risk or sovereign debt, using the notional balance
sheet of the central bank.
As the central bank buys the bonds from investors, those investors
must seek another use for the capital they have received from the sale of
their securities. Economic theory holds that some of that money should
wind up being put to productive use in the real economy, stabilising
the economic system and fostering an environment of high liquidity,
and low long-term interest rates. This article is not set up to judge that
effectiveness, but notes only that it happened and at a staggering scale.
In the US, the Federal Reserve increased its balance sheet from
roughly $900 billion of securities to over $4.2 trillion, buying US
Treasuries and Agency Mortgage-Backed Securities over the span of
the last 10 years. The Fed was actively buying new bonds to increase
its balance sheet through 2013 and has since held in place a policy to
Higher interest rates are something that captive owners have
been hoping for since the end of the credit crisis. It is hard
to put a date on how long that is, but certainly it has been
at least seven years since there has been some degree of
stability in the US economic recovery, post-crisis and recession.
Despite reasonable economic growth, intermediate and long-term
interest rates in the US have failed to move higher at all. In fact, the 10-
year US Treasury note currently trades nearly 1 percent LOWER than the
prevailing rate at the end of 2010. The US Federal Reserve has moved
short-term rates very gradually higher, away from the zero bound, in four
25 basis point increments over the course of the last 22 months.
While this has been welcome and has helped cash yields somewhat,
buying a five-year US Treasury at under 2 percent still seems pretty
unexciting. Despite the four rate increases, the five-year Treasury
is at a similar yield as at the end of 2010. Is there a trigger point, as
a result of which longer-term rates will move higher? Although we don’t
have a working crystal ball at the moment, we can think of a plausible
scenario under which interest rates in the US can move materially higher.
The rise of QE
In order to lay out the conditions for a material move higher in rates,
we need to go back to the credit crisis and its aftermath. In order to
inject liquidity and stability to financial markets during the recession,
global central banks eventually set interest rates at ultra-low or even
negative levels. Although interest rates were never set below zero