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Timeline: How the Global Economy Played Out in 2015

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Timeline: How the Global Economy Played Out in 2015

Timeline: How the Global Economy Played Out in 2015

Many people start a new year with renewed optimism. However, the reality of each new year is not so detached from the previous.

That’s why on the first trading day of 2016, optimism in the markets was short-lived as news out of China was quick to spook investors.

Chinese manufacturing continued to contract for the 10th month in a row in December. The “blue chip” CSI 300 index fell until trading was halted, with losses capped at 7% – its biggest fall in nine years. China also lowered its guidance on the yuan, which dropped to its lowest levels since 2011.

These concerns, along with other disappointing numbers out of the US and UK, eventually spread to other markets. The Nikkei was down 3%, the FTSE 100 was down 2.4%, and the German DAX down 4.3% for its worst opening day to a new year in history.

U.S. markets were in the same boat, opening the day down 2%. Canada’s TSX and TSXV are down less than 1% with much of the damage to commodities already being done.

New Year, Same Problems

Most investors and central bankers find themselves between a rock and a hard place to start 2016.

The Federal Reserve finally raised rates in December, but mainly in the interest of preserving credibility.

While unemployment itself has looked good enough and there has been some wage growth, the labor force participation is at 62.5%, which is essentially its lowest mark since 1977. Meanwhile, the stock market has been volatile, junk bonds have been hammered, and manufacturing contracted in December at the fastest pace in the U.S. in more than six years.

Most major central banks still have rates close to zero, which gives little policy ammunition for any additional stimulus. The flipside of these record-low rates has been soaring (or extremely bubbly) asset prices that have failed to trickle down to Main Street.

A slowing China and general oversupply has led to slumping commodity prices.

Oil has been hammered down to its lowest price since 2003. Copper is trading at $2/lb, which is comparable to its price during the Financial Crisis. These low input prices, in theory, are great for consumers and manufacturers. In reality, however, they usually mean that economic growth is grinding to a halt.

It’s hard to say where markets will turn in 2016, but for now it will continue to be much of the same volatility until the picture becomes clearer.

Original graphic by: The Straits Times

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Central Banks

Visualizing the 700-Year Fall of Interest Rates

Could interest rates enter negative territory permanently? This chart plots trend data over 700 years, showing that it could be a possibility.

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eight centuries interest rates

Visualizing the 700-Year Decline of Interest Rates

How far can interest rates fall?

Currently, many sovereign rates sit in negative territory, and there is an unprecedented $10 trillion in negative-yielding debt. This new interest rate climate has many observers wondering where the bottom truly lies.

Today’s graphic from Paul Schmelzing, visiting scholar at the Bank of England (BOE), shows how global real interest rates have experienced an average annual decline of -0.0196% (-1.96 basis points) throughout the past eight centuries.

The Evidence on Falling Rates

Collecting data from across 78% of total advanced economy GDP over the time frame, Schmelzing shows that real rates* have witnessed a negative historical slope spanning back to the 1300s.

Displayed across the graph is a series of personal nominal loans made to sovereign establishments, along with their nominal loan rates. Some from the 14th century, for example, had nominal rates of 35%. By contrast, key nominal loan rates had fallen to 6% by the mid 1800s.

Centennial Averages of Real Long-Term “Safe-Asset”† Rates From 1311-2018

%1300s1400s1500s1600s1700s1800s1900s2000s
Nominal rate7.311.27.85.44.13.55.03.5
Inflation2.22.11.70.80.60.03.12.2
Real rate5.19.16.14.63.53.42.01.3

*Real rates take inflation into account, and are calculated as follows: nominal rate – inflation = real rate.
†Safe assets are issued from global financial powers

Starting in 1311, data from the report shows how average real rates moved from 5.1% in the 1300s down to an average of 2% in the 1900s.

The average real rate between 2000-2018 stands at 1.3%.

Current Theories

Why have interest rates been trending downward for so long?

Here are the three prevailing theories as to why they’re dropping:

1. Productivity Growth

Since 1970, productivity growth has slowed. A nation’s productive capacity is determined by a number of factors, including labor force participation and economic output.

If total economic output shrinks, real rates will decline too, theory suggests. Lower productivity growth leads to lower wage growth expectations.

In addition, lower productivity growth means less business investment, therefore a lower demand for capital. This in turn causes the lower interest rates.

2. Demographics

Demographics impact interest rates on a number of levels. The aging population—paired with declining fertility levels—result in higher savings rates, longer life expectancies, and lower labor force participation rates.

In the U.S., baby boomers are retiring at a pace of 10,000 people per day, and other advanced economies are also seeing comparable growth in retirees. Theory suggests that this creates downward pressure on real interest rates, as the number of people in the workforce declines.

3. Economic Growth

Dampened economic growth can also have a negative impact on future earnings, pushing down the real interest rate in the process. Since 1961, GDP growth among OECD countries has dropped from 4.3% to 3% in 2018.

Larry Summers referred to this sloping trend since the 1970s as “secular stagnation” during an International Monetary Fund conference in 2013.

Secular stagnation occurs when the economy is faced with persistently lagging economic health. One possible way to address a declining interest rate conundrum, Summers has suggested, is through expansionary government spending.

Bond Yields Declining

According to the report, another trend has coincided with falling interest rates: declining bond yields.

Since the 1300s, global nominal bonds yields have dropped from over 14% to around 2%.

bond yields declining

The graph illustrates how real interest rates and bond yields appear to slope across a similar trend line. While it may seem remarkable that interest rates keep falling, this phenomenon shows that a broader trend may be occurring—across centuries, asset classes, and fiscal regimes.

In fact, the historical record would imply that we will see ever new record lows in real rates in future business cycles in the 2020s/30s

-Paul Schmelzing

Although this may be fortunate for debt-seekers, it can create challenges for fixed income investors—who may seek alternatives strategies with higher yield potential instead.

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The History of Interest Rates Over 670 Years

Interest rates sit near generational lows — is this the new normal, or has it been the trend all along? We show a history of interest rates in this graphic.

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The History of Interest Rates Over 670 Years

Today, we live in a low-interest-rate environment, where the cost of borrowing for governments and institutions is lower than the historical average. It is easy to see that interest rates are at generational lows, but did you know that they are also at 670-year lows?

This week’s chart outlines the interest rates attached to loans dating back to the 1350s. Take a look at the diminishing history of the cost of debt—money has never been cheaper for governments to borrow than it is today.

The Birth of an Investing Class

Trade brought many good ideas to Europe, while helping spur the Renaissance and the development of the money economy.

Key European ports and trading nations, such as the Republic of Genoa or the Netherlands during the Renaissance period, help provide a good indication of the cost of borrowing in the early history of interest rates.

The Republic of Genoa: 4-5 year Lending Rate

Genoa became a junior associate of the Spanish Empire, with Genovese bankers financing many of the Spanish crown’s foreign endeavors.

Genovese bankers provided the Spanish royal family with credit and regular income. The Spanish crown also converted unreliable shipments of New World silver into capital for further ventures through bankers in Genoa.

Dutch Perpetual Bonds

A perpetual bond is a bond with no maturity date. Investors can treat this type of bond as an equity, not as debt. Issuers pay a coupon on perpetual bonds forever, and do not have to redeem the principal—much like the dividend from a blue-chip company.

By 1640, there was so much confidence in Holland’s public debt, that it made the refinancing of outstanding debt with a much lower interest rate of 5% possible.

Dutch provincial and municipal borrowers issued three types of debt:

  1. Promissory notes (Obligatiën): Short-term debt, in the form of bearer bonds, that was readily negotiable
  2. Redeemable bonds (Losrenten): Paid an annual interest to the holder, whose name appeared in a public-debt ledger until the loan was paid off
  3. Life annuities (Lijfrenten): Paid interest during the life of the buyer, where death cancels the principal

Unlike other countries where private bankers issued public debt, Holland dealt directly with prospective bondholders. They issued many bonds of small coupons that attracted small savers, like craftsmen and often women.

Rule Britannia: British Consols

In 1752, the British government converted all its outstanding debt into one bond, the Consolidated 3.5% Annuities, in order to reduce the interest rate it paid. Five years later, the annual interest rate on the stock dropped to 3%, adjusting the stock as Consolidated 3% Annuities.

The coupon rate remained at 3% until 1888, when the finance minister converted the Consolidated 3% Annuities, along with Reduced 3% Annuities (1752) and New 3% Annuities (1855), into a new bond─the 2.75% Consolidated Stock. The interest rate was further reduced to 2.5% in 1903.

Interest rates briefly went back up in 1927 when Winston Churchill issued a new government stock, the 4% Consols, as a partial refinancing of WWI war bonds.

American Ascendancy: The U.S. Treasury Notes

The United States Congress passed an act in 1870 authorizing three separate consol issues with redemption privileges after 10, 15, and 30 years. This was the beginning of what became known as Treasury Bills, the modern benchmark for interest rates.

The Great Inflation of the 1970s

In the 1970s, the global stock market was a mess. Over an 18-month period, the market lost 40% of its value. For close to a decade, few people wanted to invest in public markets. Economic growth was weak, resulting in double-digit unemployment rates.

The low interest policies of the Federal Reserve in the early ‘70s encouraged full employment, but also caused high inflation. Under new leadership, the central bank would later reverse its policies, raising interest rates to 20% in an effort to reset capitalism and encourage investment.

Looking Forward: Cheap Money

Since then, interest rates set by government debt have been rapidly declining, while the global economy has rapidly expanded. Further, financial crises have driven interest rates to just above zero in order to spur spending and investment.

It is clear that the arc of lending bends towards ever-decreasing interest rates, but how low can they go?

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