Sunday , 31 May 2020


What Are the Implications of Long-Term Rates Dropping To 0%?

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While I’m going to pass along my thoughts to you, I want to emphasize that I wasn’t, and still am not, able to anticipate the most important things happening in the markets because of the extremely rare nature of the circumstances…[so please] take or leave…[what I am about to say] as you like. 

Long-term interest rates hitting the…0% floor means that:

  • virtually all asset classes go down because the positive effects of interest rates falling won’t exist (at least not much)…
  • virtually all the reserve country central banks’ interest rate stimulation tools (including cutting rates and yield curve guidance) won’t work.
  • the printing of money and buying of debt assets that central banks are now allowed to buy almost certainly won’t work much (because bonds can’t be pushed much higher and they are also less likely to be sold to buy other assets of entities that are in financial trouble)…
  • real interest rates will likely rise because there will be disinflation or deflation resulting from lower oil and other commodity prices, economic weakness, and more credit problems…@A Financial Site For Sore Eyes & Inquisitive Minds
  • rising credit spreads will raise debt service payments to weaker credits at the same time as credit lending shrinks, which will intensify the credit tightening, deflationary pressures, and negative growth forces…

If things stay exactly where they are…

  • pension funds and insurance companies and others that have long-term liabilities that are funded with these equity and equity-like assets…will come up short [and will likely] have to…sell assets to make payments…
  • oil producers (countries and companies) will see their expenses become much greater than their revenues, and… have to…slash spending and sell assets.

…Most investors and businesses are long (i.e. holding assets hoping that they will go up in price) on a leveraged basis (financed with debt) so that the declines in asset prices that we are seeing will have even bigger financial effects than the non-leveraged price declines that we are seeing.

Contrary to popular thinking, the markets will have a bigger effect on the economy than the economy will have on the markets. For that reason, calculating who is in what positions and figuring out what they will need to do because they are in those positions (e.g., cut expenses, sell assets, etc.) is most important…

Our biggest economic risk comes from the possibility that our elected officials (who are the ones who control fiscal policy) will handle it badly. That is because it’s tough enough to know what to do during a big crisis and then do it boldly even when there aren’t divisive politics. With the divisive politics it might be impossible.

While some fiscal stimulation measures are being put into place, they’re not large or targeted enough to neutralize the contagion of the economic and market effects of the virus, and they are being argued about. However, there are some emerging signs that some important policy makers might move to a “whatever it takes” posture. If so, then we will have to see if works given the previously described circumstances being so limiting…

President Trump might be in favor of a big stimulation, though there are no signs that it will be targeted where it needs to go most or of a size that it needs to be. Regarding his priority of getting re-elected, he is in serious risk of doing too little too late, and what president trying to be re-elected wouldn’t love to have big fiscal stimulation going into the election, so I would think that he could move into the “we will do whatever it takes camp.”…

For now, there hasn’t been much focus on relatively targeted measures, which I believe are most important because specific areas need the most help for this debt/economic problem not to spread. I’m not saying that nothing [has been done]…but they are relatively small and offer modest support to those with economic problems. They will need to be much bigger.

…Thus far, there has not been much debt support to industries that would go broke due to this shock although President Trump has called for Congress to authorize an additional $50 billion in subsidies for loans to SMEs through the SBA. This could free up a few hundred billion dollars in loans; however, it’s not big enough and it’s not clear whether this measure will garner congressional Democrats’ support…

In summary, I believe that:

  1. the 0% interest rate floor and the absence of other effective central bank tools requires much greater fiscal stimulation that is targeted to hit the most important pain points, with the cooperation of central banks holding rates down and providing plenty of liquidity,
  2. the response thus far has been inadequate in size, focus, and coordination but that has varied a lot by country,
  3. in the last few days there have been signs of fiscal and monetary policy makers moving to much stronger “do whatever it takes” policies, and
  4. the wealth and political gaps will test social and political abilities to cooperate and help rather than hurt each other in dealing with these problems. 
Editor’s Note:  The original article by Ray Dalio has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy.  The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.  Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

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