It’s the most important question in finance today.
It affects everything – stock prices, bond prices, house prices; economic growth, business investment, employment; even people’s behaviour.
And it’s what I’d like to consider in today’s Money Morning.
When, if ever, are interest rates going to go up? And by how much?
No country for fixed-rate mortgages
I ran into a (very successful) friend of mine from the entertainment industry a fortnight ago. Suddenly, in the middle of the conversation, he blurted out: “Sorry, I have to get his off my chest. I saw you at so and so’s wedding in spring 2008 and you were saying there was about to be a huge financial crisis.”
“Well? I was right,” I said.
“I was just arranging a mortgage at the time and because of what you said I fixed it for five years. Cost me an absolute fortune!”
I know several other people who did the same thing.
Many saw the crisis coming, but didn’t foresee the extent to which debtors would be bailed out. We underestimated the political intervention. As we all know, the prudent paid.
There is a serious political and moral issue here, but our scope here is not to pass judgement or change the world. It is to help make investment decisions.
Politics, however, is hard to avoid with a subject like interest rates, because they are so manipulated. Money itself is manipulated. It has become, as well as a medium of exchange and a store of value, a political tool.
As I see it, we are stuck in an economic rut in which the system is rigged in favour of the debtor. The thing to understand as an investor is that this bias won’t change until the system does – and I don’t see it changing any time soon. There is neither the political will nor the understanding, and Mr Market is not (currently) forcing anyone’s hand.
That, I suggest, is the economic reality of the world in which we live.
Take the official measure of inflation – the consumer price index (CPI). The Bank of England uses CPI to make its decisions.
You have been able to see, in real time, the huge asset price inflation that has followed all the money creation since 2009, particularly in London property and equities. Think tank Positive Money reckons that 40% of newly created money has gone into residential and commercial property, and 37% into financial assets.
Yet property prices and stock and bond prices are not included in the CPI. So it is possible for the bank to actually ignore, if it so chooses, the asset price inflation – some would say bubbles – its policies are creating.
CPI only measures the impact of about 10% of money creation. Thanks to falling commodities prices, it currently stands at 0%. It will probably slip into negative territory when the next numbers come in. We are already being warned about deflation. If anything – based on the numbers it uses – the bank’s reaction should be to cut further.
So, thanks to its chosen inflation measure, the BoE can argue that there is no good reason to raise rates.
How to profit from ongoing interest rate suppression
Zero interest-rate policies (Zirp) exacerbate the wealth gap: they reward capital and penalise labour; they reward the debtor and penalise the saver. But while the wealth gap may be a major talking point among voters, politicians are doing nothing to address it.
The housing crisis is a perfect example. There is an easy solution – cheaper homes. But rather than allow house prices to fall to affordable levels, they prop them up with lower rates and bring in ‘Help to Buy’.
Like it or loathe it, this is the way the economy now works. Whether it’s Balls or Osborne who ends up in Number 11, neither will risk this money bubble popping on their watch.
Debtors carry more political weight than savers. Asset owners (the old) carry more political weight than the under-35s. This might change by the time the asset-poor under-35s become the asset-poor under-50s, but we are not there yet. Low interest rates are the ‘new normal’, and that normality is not going to change soon.
So how do you invest to take account of all of this?
The simple answer is to invest in assets that benefit from Zirp. Over the past few years, those assets have included American stocks, London housing and, if you’ve bought and sold well, various types of bonds.
But even in a Zirp world, these assets are looking fully valued (though I still like tech stocks). US stocks are expensive relative to other world markets and to history. London property looks very dodgy and is hanging by a thread, which, with every finished new-build, gets more and more tenuous.
As for the bond markets, investors are very much playing the game of finding a greater fool to sell to. You can still make money in these areas, but you have to be careful, as these bull markets are all long in the tooth.
If you’d said ‘Zirp’ to me five years ago, I’d have said go for gold and possibly other commodities too, but these are now in entrenched bear markets. One can make the case that the worst is now over, but any purchases here would be bottom-fishing. And bottom-fishing is dangerous.
If you’re from the ‘keep it simple’ school of investing, go where the money is being printed. At the moment, that’s in Europe. The European Central Bank (ECB) is electronically creating some €1.1trn.
Some of this has already been priced in to European stocks, of course, and they have had a strong 2015. But, relative to the US, there’s plenty of room for them to move higher. Bull markets can go on for a long time.
So if you want Zirp to work for you, track the stock markets of France, Italy, Spain, and, of course, Germany – preferably with your currency exposure hedged. (Jonathan Compton looked at other ways to buy Europe in a recent issue of MoneyWeek magazine).
• Dominic Frisby is the author of Life After The State and Bitcoin: the Future of Money.
Category: Market updates