Markets May Be Wrong This Time
How much would you pay a bank to hold your savings account? You would be incredulous if this was the case, of course, because you would say
banks pay me for my savings, I don't pay them
.
So how is it that this phenomenon exists in Japan and across Europe where negative interest rates cause this very thing? Savers in these areas of the world actually pay to have savings in the bank. Why? Because these countries have too much in savings, not enough consumption and investment, and their central banks (institutions like our Federal Reserve) have forced rates into negative territory to coerce savers to go out and spend. They are trying to make savings painful by being costly. Unfortunately this plan is not working as growth rates in these areas of the world are consistently stagnant.
It's Not Just Us Anymore
When it comes to interest rates, think globally, not just domestically. Our economy is humming, unemployment is at some of the lowest levels ever, savings are up - all signs that interest rates should be much higher given all this vibrance. But they're not, they are at record low levels. Why is this?
Why you need to think globally:
So, if you had a billion in any currency in your possession (congratulations) and you needed absolute safety along with liquidity, where would you put that billion now? Let's see - we could put the billion into German short-term government bonds because they are safe and liquid. Yes, that happens to be true, but guess what? They are charging you to keep their money there. That cost could be a big expense on a billion. As you ponder other places to stash that cash, you would probably not plunk it down into, let's say, Madagascar banks where interest rates are around 9.5% (
tradingeconomics.com
), you want and need safety and enough banking infrastructure to hold your funds. So you look around and realize that the U.S. currently does not charge you to keep your money there - they have positive interest rates and total liquidity and lots of safety. You decide that's where you want to put your money for now, but there is a slight problem.
Everyone else is as smart as you (they had high SAT scores too) and they've decided to do the same thing.
Well, we know that when there is great demand for anything, the price goes up - and when bond prices go up, the yield goes down and that is exactly what has happened here in the U.S.
So our perception is that interest rates have come down not because a recession is on the horizon (current statistics paint a strong economy), which historically has been the case, but rather that demand from around the globe for U.S. bonds is very high due to negative rates in developed countries.
Where Are Markets Now?
In the meantime, the stock market thinks that low interest rates (and what those savvy economists refer to as inversion of the yield curve) are good recession forecasters. As we note above, this may not be the case this time around. The
Leading Economic Index
produced by the Conference Board is a much more historically accurate recession forecaster and that indicator is not yet flashing recession risks. Watch for the next update out in the next few days.
Stocks React to Interest Rates:
Concurrently with interest rates declining, recession fears have pushed bonds up and stocks down. The
broadest measure of stocks, the Vanguard World Index is now down 6.8%
from its high, while the S&P 500 has declined similarly.
(1)
Riskier stocks (small, midcap and emerging markets) have declined more as they do and should in market drawdowns.
(1)
Our quality stocks have been resilient and have held up marvelously well as they should during market trepidation and as they have historically.
(2)
Also keep in mind that stocks were lower in May three months back - down a little over 7% from their April lower starting point.
(1)
For all the excitement, the S&P 500 is still up about 15% year-to-date.
(1)
Other causes of market volatility? Tariff talk. We will see how this plays out by year-end - if there is tariff consensus, watch markets rise significantly upon resolution.
Let's see how this plays out...
