Markets have been worried that interest rates in the west are heading back to normal in a hurry. If rates go too high too soon they could damage the recovery and do more harm to shares.
As the West agonises over the pace of putting up interest rates and winding down special monetary measures, the East reminds us there is nothing new in all this. During the years between 1990 and 2010 most commentators in the West ignored the plight of Japan, struggling with the long shadow cast by its asset inflation and banking crash of the late 1980s. Japan tried various forms of Central Bank assistance, settling into long and large programmes of Quantitative easing, and tried out negative rates of interest. These were to become mainstream in the West as well after the crash of 2008-9. Japan showed to anyone interested that low rates and no rates, and money creation, can last for a very long time if there is no inflation response to the special measures.
Today the 4.35% official lending rate in China and the 6% short rate in India is a reminder that normal can mean interest rates considerably higher than we are now used to in the West. The Chinese and Indian economies can grow at fast rates despite these much higher interest rates, and seem to need higher rates to control inflation. Indian inflation remains obstinately high at 5%, whilst Chinese inflation is running near the 2% Japan and the Euro area would like to achieve.
The US has now reached its 2% inflation target, with core inflation getting up to that level. That has led to rate rises and justifies some more to come. This does not mean that US rates are set for 4-5% anytime soon in the way they used to be fixed before the crisis. It is just a reminder that the idea there is some normal rate of interest is misleading. Rates will be set by Central Banks in relation to past data as it emerges, and influenced by what they think might happen next. Few think western inflation after several years of sleeping is about to awaken dangerously. The West does not have the kind of inflation problem India or some of the Latin American economies still experience. Price rises are kept under control by fierce global competition in the goods market, by the growth of robotics and artificial intelligence keeping down employee costs, and is reinforced by plenty of migration exerting downwards pressure on wages.
The absence of strong inflationary pressures in Japan means more of the same monetary medicine is likely. The way Euro area inflation stays well under target means the ECB is unlikely to raise rates this year. The market has worried a lot in the last few days over the future trend of US rates. Whilst we would expect some pick up in pay from one off bonuses and some basic pay rises following the tax cuts, it does not look as if the global market will allow a major wage led inflationary surge. The presence of more cash in companies does not suddenly remove the power of automation to cut employee costs, or the powers of the global market to keep first world wages down a bit.
The likelihood of several US rates rises is a widely held view, so when they come they should not be a shock. Markets will understandably focus on the monthly inflation and wage figures to see if there will need to be more rate rises than currently imagined. Meanwhile the good news is all this is only a credible worry if you think the US economy is going to grow faster this year, and that US companies are going to be so cash rich they will be willing to pay more to their staff. This is a cloud which comes with its own silver lining for share investors. Moderately higher pay means more money to spend and more activity in global markets. In Europe shares, on average, give you a better income than high grade bonds, and benefit from more growth. Markets may continue to worry about the yield on bonds, but it is difficult to believe the authorities are about to abort the recovery it has taken them so long to create on both sides of the Atlantic.
The above article was first published by Charles Stanley on 14th February 2018