What low rates and high prices mean for investors

What low rates and high prices mean for investors

With few underpriced assets and interest rates at historical lows, do investors face a bubble or a stable– and unprecedented– leveling in markets?

Spain, the jittering economy that recently prompted fears about a disastrous eurozone meltdown, sold 10-year bonds at bargain rates in June — rates that claimed the lowest yield since at least 1789, making them even cheaper than US debt.

Spain is not alone in this regard. France and Italy have also experienced collapsing bond yields, and has been dubbed The Great Insanity to match The Great Recession. One only has to go back to 2011 to find statements such as “contagion is alive and well,” a quotation from Rebecca Patterson, chief market strategist at J.P. Morgan Asset Management.

As late as 2012, an analyst affirmed that “confidence on peripheral sovereign bonds and banks has been crumbling, as interest rates and credit default swaps (CDS) spreads rose in the past weeks.” Since then, there has been a remarkable turn.

The charts below are taken from Deutsche Bank’s Jim Reid, who notes that “10-year French yields hit 1.654 intra-day which was the all-time low covering our entire data history back to 1746. 10 year Spanish yields also hit all time lows with our data going back to 1789. Italy has only been lower in yield for a few months in early 1945 (data back to 1808).”

In London, talk about a housing bubble does not even have a ring of uncertainty about it. A BBC headline from last month read, “Can the Bank of England curb the housing bubble?

Prices in London and the Southeast have risen by approximately 20 percent annually, leaving buying and even renting out of reach for many. Exorbitant real estate prices are not news in the UK, where the undersupply of housing has accelerated the cost of housing since the Thatcher years.

The question is whether skyrocketing real estate prices in parts of the UK are the workings of supply and demand or whether they are entering unsustainable bubble territory.

In debates about whether current stock or housing prices are reasonable, those who claim they are fair frequently refer to business cycles as determinants of relative cheapness, and to the fact that many indices have not yet regained what was lost in the Great Recession. This may well be the case for some asset classes, where scarcity drives up prices in a “natural” fashion.

Yet the historic lows of risky sovereign bonds cannot be so easily dismissed. Current rates dubiously suggest virtually no chance of France, Italy or Spain defaulting or the eurozone falling apart.

The risk may be small at this point, but it is not zero. Low rates, furthermore, could mean less incentive for peripheral euro nations to undertake the economic and social reforms that have served as a premise for their bailouts (and arguably the low rates).

Seeing as the Fed, the Bank of England and the ECB have little intention of raising rates beyond the diminutive upward revisions they have exercised so far, cheap liquidity is likely to remain for the foreseeable future. As such, a bubble is still viable.

What is new about today’s scenario, however, is the breadth of it. Nothing is cheap. Even emerging markets, junk bonds and risky stocks yield very low returns relative to risk. The New York Times labels it either the Everything Boom or the Everything Bubble. Future events, and in particular central bank policy, will tell which of the two it is.

Categories: Finance, International

About Author

Mikala Sorenson

Mikala Sorensen is an Economist with regional expertise in Europe. She holds a first class honours degree in Philosophy, Politics and Economics from the University of York and a Masters in Economics from the University of Copenhagen. Having interned at the Danish OECD-delegation in Paris and currently working at the Danish Ministry of Finance, she specialises in politics and macroeconomics. Analysis for GRI is an expression of her own views.