The Strategist

Will Japan-like stagnation infect the world?

12/10/2019 - 09:59

This year, economists again spoke loudly about the world economy stepping on the Japanese way. This “disease” has already swept Japan and Europe, where it came in the form of quantitative easing and negative interest rates on deposits and bonds. Experts fear that next year it will spread to the rest of the planet, including the United States. There are prerequisites for this, as follows from an analysis of the dynamics of the behavior of the yield curve. In the event of a recession, the Fed will have to follow the example of colleagues from Japan and the eurozone and return quantitative easing.

So far, neither the Fed, which this year has already cut interest rates three times, nor the ECB are going to take any radical action. The main American bank is likely to take a break and will not touch the rate until at least the first quarter of next year.

“Central banks have no other choice but to maintain risky assets and their prices until financial expansion becomes possible,” said Richard Hodges of Nomura Asset Management.

In Italy, political risks had practically no effect on investors who forecast zero rates next year amid forecasts that the ECB could reduce them again.

In Greece, where seven years ago the cost of borrowing reached 44%, now rates have fallen to 1.5%.

Negative rates and monetary stimulus by the ECB helped strengthen the position of the weakest members of the eurozone. On the other hand, they made it difficult for banks to make a profit. Pension savings were also at risk.

UK and Australia may well enter zero and negative rates in the near future.

“Japanization will take a long time,” explains Chris Rands, manager of Australian financial company Nikko Asset Management Ltd. “The main problem is hiding in Europe. Once they sneeze, we get a cold.”

The main bank of Australia lowered interest rates to a record low of 0.75% and now, most likely, will join the ECB and Bank of Japan and introduce a program of quantitative easing of the economy for the first time in the country's history.

In Britain, according to analysts at Citigroup Inc., a tipping point could be a hard Brexit, i.e. withdrawal from the European Union without an agreement. Its probability has not completely disappeared yet.

However, saving economies from imposing negative rates alone may not be enough. Despite good data on the labor market, rates on ten-year US government bonds fell below 2% in August and have not risen since then.

Jack McIntyre of Brandywine Global Investment Management believes that interest rates will remain at the same low level next year, but do not exclude the possibility that rates on ten-year bonds may fall below a record 1.318% (2016).