In a prior post, we mentioned that the FOMC and global central banks have started lowering interest rates. There has been an ongoing debate among financial market commentators about how this will impact the economy and financial assets. One of the biggest factors of this debate is whether global central banks and governments have enough room to provide the same level of historical stimulus as prior periods of policy easing. We decided to look at the current data points to compare the current conditions to prior cycles when central banks lowered interest rates.
Starting with current interest rate levels, it is evident that real and nominal interest rates are already extremely low. Globally, 22% of countries have negative nominal 10-year yields and 51% have negative 10-year real yields. Those are both record highs and much higher than levels at the beginning of the last rate cutting cycle in 2007.
Real and nominal 10-year government bond yields in globally important countries, such as the U.S. and Germany, are well below the levels that they were in 2007.
Global short-term rates, set by central banks, are also well below 2007 levels on a real and nominal basis.
Again, real and nominal central bank rates are well below 2007 levels in the U.S. and Europe.
Based off this analysis, it appears that central banks have less ability to provide stimulus to the economy and financial markets from lowering interest rates levels now compared to prior periods.
A monetary tool that was unique to this cycle has been the use of quantitative easing, which has led to a large increase in central bank balance sheets.
The size of U.S. and Chinese central bank balance sheets have declined as a percentage of GDP; only the U.S. has started to shrink the overall asset amount. In Europe and Japan, the absolute size of the asset base and percentage of GDP continues to increase.
Based on these data points, it appears that balance sheet growth will have a diminished impact as well, unless the amount is more significant than the last cycle.
There is a possibility that fiscal policy could play a larger role in the stimulus efforts. Historically, the impact of fiscal stimulus has been dependent on the change in the budget deficit and total government spending. In prior periods, budget deficits are typically lower by the end of an economic cycle and expand during recessions.
U.S. federal deficits are already wider than they were coming out of the 2001 recession. The Congressional Budget Office (CBO) is also projecting that budget deficits will continue to increase over the next several years. This projection is based on the assumption that there will be no recession and no changes to current spending or tax policy. In our view, the current make-up of the budget does not allow for much flexibility and deficits are likely going to continue to increase, which would require a large ramp-up in federal spending to create a boost to economic activity and financial markets. Federal debt, as a percentage of GDP, is currently larger than it was at the end of prior economic cycles, which could make it more difficult to increase budget deficits .
Current monetary and fiscal policy positions suggest that the actions taken to stimulate economic growth and financial markets may not be as effective, or may require much larger efforts, when this economic cycle ends.
Rank Dawson, CFA
Vice President, Strategic Planning
Boyd Watterson Asset Management, LLC
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.