Where are interest rates headed?
Central banks are on a path to normalisation with the cash rate expected to be 3.4% and inflation to normalise at 2.5% in two to three years time, according to BMIS.
Speaking at an Institute of Managed Account Professionals (IMAP) webinar, Brad Matthews founding director at BMIS, said his interest rate predictions could take longer, subject to the economic cycle.
“The key point that I'd like to emphasise here is that the central banks around the world… are on a path to normalisation and that's partly because inflation is on the path to normalisation as well,” he said.
“I think some of the deflationary forces which have been so dominant over the past couple of decades have probably run their course… and I do think we will see inflation settle back to a long-term average in that 2%-4% range.
“The normalisation of interest rates around that would imply a cash rate up to 1% above that, and then given that the yield curve is positively sloping 75% of the time, a longer-term average for the 10-year bond yield would be a little bit above 4%.”
Matthews said central banks had come to the realisation that they could not continue running quantitative easing and negative real interest rates into the long term.
“When you have negative real interest rates, you've actually discouraged productive investment,” he said.
“This sort of simplistic or first level assessment of falling interest rates and negative real rates would be that it would encourage businesses to borrow and spend and build productive capacity, but the experience has been quite different.
“When you look at the level of business investment compared to GDP, it's actually been on a longer term decline in this period of very low interest rates.”
He said negative real rates made investing in real assets and property infrastructure “extremely impressive”.
“So assets where effectively your income, which is inflation linked, grows faster than the discount rate or the interest rate, there almost infinitely valued,” he said.
“And I think what we’re seeing with Sydney house prices is a good example of that… so you ultimately see a shift in capital towards less productive investments and ultimately that’s not good for economic growth.”
Matthews said higher interest rates, which he noted were not going to rise dramatically, would not be recession causing or a major detractor to company earnings.
“I think growth assets will ultimately come through this okay.
“What we've seen in January and December last year, is that there is a spike in volatility and certainly equity markets don't like unexpected increases in interest rates.
“But I do think ultimately, when you invest in growth assets, you do get protection from inflation, company earnings tend to grow in line with inflation and real assets grow in line with inflation.”
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