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09 August 2019


Ten years on from the financial crisis, ‘financial repression’ continues. Central banks in most parts of the world are keeping interest rates very low, in the hope that better credit growth will support investment and consumption.

Perhaps Richard Koo’s “balance sheet recession” thesis is spot on in suggesting that, after a financial crisis impacts negatively upon balance sheets, it can take decades for the private sector to borrow again. In fact, a closer look at US interest rates in the last 150 years shows that every time there was a major financial crisis, rates stayed low for around 30 years. This was the case post the 1870s ‘Long Depression’ and the 1930s ‘Great Depression’.

Could this mean that 10 years on from the 2008 ‘Great Recession’, we are in for another 20 years of low to negative interest rates? This seems to be the view the sovereign bond market has taken. This could change if, as Koo mentions, accommodative fiscal policy is used to complement an easy monetary policy, which alone cannot solve all woes. It is still too early to tell, but we note increasing talk of governments loosening fiscal policy after years of austerity.

For now investors are being taken out of their comfort zone with flat-to-negative yielding bonds in several major countries. They also seem scarred by the two severe equity bear markets (around -50% for US equities) that occurred within a decade in 2000-2002 and 2007-2009. Markets last fell by that much in 1973- 74, 1937-1938 and in the ‘Great Depression’.

Many investors today find themselves worrying about the next crash. As retail fund flows have showed this year, retail investors have been selling equities and switching into bonds en masse. The latest AAII retail investor sentiment survey published in the US this week shows that retail investors are as bearish as they were at the end of the fourth quarter last year, similar to levels of bearishness seen in early 2016.

With financial repression continuing, the message from central banks is clear. Risk-seeking behaviour is encouraged until growth returns to a more sustainable path globally. A good reminder that investors should not forget the old adage: “do not fight the Fed” (and other central banks).