Interest rates are going up, or are they?

Two prominent Danish economists are far from agreeing on whether the business for many years ahead will have to subsist in a challenging low interest rate environment. But they do agree on one thing.

When former Fed-chief Ben Bernanke said back in 2008 that interest rates would be hovering around zero for a while, nobody ever expected that while to be nine years. Current Fed Chairwoman, Janet Yellen, increased interest rates from 0.25 percent to 0.50 percent on Dec. 16 2016. So it is an increase, but not exactly a launch into space.

In Europe the key interest rate at the moment is at -0.4 percent - a situation that almost nobody had imagined a few years back. The last time we had a positive interest rate in Europe was in 2011, when it was still at 0.25 percent.

Now the question is what the development in interest rates in the future will be. Up or down?  At FWAM we have asked two economists to share their view on the future.

Some believe that in ten years we will still be trudging through the zero interest rate wasteland, while others are sure that the interest rate will be back to normal in ten years. There are parts that they agree on, though; That Donald Trump is capable of doing much damage to the economy in a short amount of time, and that 2017 could be an entirely reasonable year for investment.

Interest rate developments in the short term

First off, a look at the interest rates and the future: In the short term, the interest rates could increase some. But sooner or later they will be too high compared to the vast amount of debt that we have accumulated, and so the interest rates will automatically be knocked back down the second they advance too much. These are the words of SEB chief economist Thomas Thygesen. Consequently, he believes that the interest rates in ten years will be more or less the same as today.

"As long as the debt is this big, any attempts at increasing the interest rates will quickly throw grit in the machinery again. The question is how far away we are from an interest rate increase that could have this effect, and how far up the interest rate can go before it starts to hurt," says Thygesen to FWAW.

"It's important to differentiate when looking at the future," Thygesen emphasizes. "In the short run we're very positive, we believe that we'll see a rise in growth, inflation, stock prices, and interest rates, but it's a different prospect over the longer term."

Debt reduction is the alpha and omega

The problem today is, according to Thygesen, that we have, throughout many crises, solved our problems by lowering the interest rates. As a result, the debt has grown to a previously unimagined size. This has to be paid back – the question is when.

"In the long term, we're stuck in the "zero interest rate environment" until we find a way to get rid of the debt. It can be written up – which is costly. So it's unlikely that anyone would do that unless they have a strong incentive," Thomas Thygesen says to FWAW, and continues his predictions: "If we look 5-10 years into the future, I don't think the interest rates will be much higher than they are today. But during such a process, there are of course ups and downs."

Frank Hvid Pedersen, head of Strategy and portfolio Management at Carnegie, is not convinced that Thomas Thygesen will be right about his expectations for the future:

"It's correct that there's still plenty of debt, and it continues to destabilize the global economy, but good things have happened too. For one thing the debt from the financial crisis has been reduced, and for another, much of the debt has been reshuffled from the private to the public sector. The public sector is much better equipped to deal with such a debt if the interest rate should go up, although, of course, it has its limits. Furthermore, much of the debt accumulation has happened in China, which is a fairly closed-off system. China has to do something about this problem in the coming years, and it will have a great deal of influence on the growth, but it will not necessarily trigger another financial crisis," says Hvid Petersen to FWAM.

Hvid Petersen both hopes and believes sincerely that interest rates will go up over the course of the next ten years: "We can expect the interest rates to return to a more average level. 200 years of economic history indicates that real interest rates don't normally remain negative or close to zero," he says, and continues with regard to Denmark: "The Danish interest rates are not at zero in 10 years: That is both a belief and very much a hope. If we have low interest rates that long, then something is seriously wrong. It would mean that the economy had completely stagnated," he says.

Room for excitement in 2017

But no matter whether we are headed towards higher interest rates or remaining in the status quo in the 10-year perspective, there's room for growth right now. Such are the predictions from both Thomas Thygesen of SEB and Frank Hvid Petersen of Carnegie:

"The combination of stronger growth and fiscal activism should allow the central banks to raise the interest rates a bit and thereby make people believe a little in higher inflation. It's just like in space: Objects that move will keep going in the same direction until they hit something that alters their course, and right now I don’t see any obstacles to the continued growth," Thygesen observes.

He indicates credit, equities, and commodity as the winners of the first six months of 2017, while bonds are likely to be the losers. The question is how long it will be before something turns up and changes our course.

Frank Hvid Petersen adds: "We have been in a deflationary environment since 1998. There's a good chance that were leaving that state. But what we're all asking ourselves now is, how long will this keep up/continue? The long-term interest rates in the US have gone from 1.3 percent to 2.6 percent – was that all? Or are we going to reach 4-5 percent?"

Trump may aid or destroy growth

If you ask Thomas Thygesen, we are not likely to reach higher than 3.5 percent before the tide turns.

"If the US interest rates reach 3.5 percent during the next year, then it need not crawl much higher before house prices start to drop, and it turns out that such an interest rate environment is not sustainable."

Thygesen assesses that we are halfway through the process that will lead to the playoff and thereby back to the zero interest rate environment.

"If the Fed really has to push the short-term interest rates, then as a consequence, at some point the long-term interest rates will go down – or the rise will be brought to a halt due to a belief that interest rate increases from the Fed will suppress growth and inflation. But we’re not quite there yet."

As the situation is right now, unemployment in the US has been reduced considerably, and growth is on the rise.

One contributing factor is the new president of the US, Donald Trump. Markets have begun commending his prospective tax cuts and other political initiatives. If he successfully implements these changes, it could rather quickly send growth, and thereby also inflation and interest rates, skyrocketing.

But it is also "The Donald" who could destroy the entire growth scenario with a single misguided tweet or similar unpredictable incidents. Both of the economists agree on this.

The dance around monetary policy

Another question that suggests itself during these months is that, maybe, we are getting so thoroughly stuck in the mud that we might have to pull ourselves together soon and not simply leave regulation of the economy to the central banks? That it is about time for politicians to start interfering and utilize fiscal policy as a tool. The discussion is ongoing, and a growing number of voices call for the use of fiscal policy as a tool.

"When we get a "reset" like we did in the 1940s, things happen. It probably requires some redistribution of money, a depreciation of debt, and some considerable political undertakings that I don’t really see being carried out until we're in the middle of a crisis where politicians may feel compelled to do it. With this in mind, I'd say that we still have another cycle to go before we can expect a lasting rise in interest rates. For as long as the debt is still in the picture, there will be obstacles in the way of a short-term rise in interest rates," concludes the chief economist of SEB.

However, Frank Hvid Petersen does not agree. He believes that way too many call for fiscal initiatives without nobody knowing whether or not it would work or what effect it might have.

"Who says that monetary policy can kickstart anything? Even the World Bank and OECD, which earlier on have been extremely rightist, say today that it would have positive effects to loosen fiscal policies. But we don't know. Sadly, we can't perform little economic experiments on trained mice," Frank Hvid Petersen points out. He also points to the problematic aspect of everyone being accustomed to central banks and governments jumping to the rescue at the mere indication of adversity.

"It is ultimately counterproductive, because every time has to be a little more extreme than the last," says Carnegie's head of Strategy and portfolio management.

No low-hanging fruit nowadays

With all the economic events over the past few years – heavy declines in the share markets, negative interest rates, QE programmes, and much more – one could get the notion that life as an investment manager is not as easy as was just 20-30 years ago. But also here opinions vary:

"It was easier earlier on. Crises were small and bull markets were lengthier. If you just kept to your own, it couldn't go wrong," says Thomas Thygesen. He continues, "In the environment that we have today, there's a world of difference between good times and bad times, and it is nearly impossible to build a portfolio that can handle both scenarios satisfactorily."

At Carnegie in Copenhagen, the view on the working conditions is somewhat different:

"A colleague back in the 90s once said, quite Rube Goldberg-like: Frank, it has never been more difficult to tell the future than it is now." It has always been difficult – try living in the '80s with interest rates at 15-20 percent, or when the Berlin Wall fell, or suchlike events. Nothing is static, so the level of difficulty hasn't changed that way. Creating profit is more challenging today. Most assets have become more expensive today. They have, and it is challenging for the trade. As a result, there’s also this massive focus on costs and on the choice between action or inaction," concludes Frank Hvid Petersen.

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