Warning: The era of negative real interest rates is likely to come


With the long-term trend of declining interest rates and rising inflation (alas, with increasing signs of non-transition), more and more debt instruments have real interest rates of increasingly negative, warn Les Nemethy and François Lesegretain.

“Bonds are not the place to be these days [….]. Fixed income investors around the world, whether they are pension funds, insurance companies or retirees, face a bleak future, ”said Warren Buffet. Even nominal returns are increasingly negative.

The first part of this article discusses why this trend is likely to continue or even increase. The second part deals with how to protect yourself in this type of environment.

So why are negative real interest rates here to stay? In short, the debt spiral and money printing are already out of control. With total global debt at over 350% of global GDP, US government debt at over 160% of US GDP, and Japanese government debt at over 230% of GDP, to name a few , governments are struggling to escape a growing spending deficit. Despite record interest rates, Japan spends more than 20% of its GDP on interest expense.

The graph shows an increasing trend in assets on the balance sheet of the US Federal Reserve, which has bought bonds and other assets in order to reduce yields.

Over the past decade, there have already been four attempts to reverse the trend, each resulting in a ‘tantrum’ (for example, when markets collapse, requiring a massively increased stimulus to revive the economy. ).

With governments, businesses and individuals all addicted to debt, the only real option for central banks is to let inflation exceed interest rates by at least 3-4% so that they can come out. from the mountain of debt. There is a precedent for this: the United States pursued precisely this strategy to manage the debt accumulated during World War II.

Helicopter money

As monetary policy (low interest rates and bond purchases controlled by central banks) reaches its limits, governments are also embarking on the stimulus act through so-called helicopter money and deficit spending.

Governments also guarantee loans made by banks, which means that there may be a dramatic increase in bank lending, through which new money will be created.

Manufacturers are starting to experience severe shortages of inputs, from steel to microchips. Container shipping costs are skyrocketing; labor shortages are popping up everywhere. The velocity of money has fallen so low over the past decade; it has no other option but to increase, once again fueling inflation.

How to protect yourself in this environment? The current investment environment has been called in many ways, from the “everything bubble” to the “powell put”.

Inflation turns money into garbage: pensions are likely to be ravaged by inflation. Under these conditions, where to park your fortune? This is perhaps the most pressing problem facing investors in an inflationary environment. There is a thirst for yield, which drives most valuations towards the stratosphere.

We see three outlets for species in this environment:

1. Physical assets, including real estate, farmland, etc.

2. Company shares.

3. Raw materials, and inside them, ingots.

Note that bonds are not on my list. Someone who buys bonds with ultra-low yields receives low interest in exchange for taking a substantial risk that higher inflation or soaring rates could more than wipe out the gains.

Knowledge and Quality

But it is important to note that there is quality research within each of the three asset classes above, and knowledge of each market becomes essential; it’s all too easy to find real estate, publicly traded stocks, or commodities that will perform poorly in the years to come.

But if you have the time and knowledge to research quality stocks or real estate that generate cash flow, are well managed, and have the potential to generate ever-increasing cash flow, chances are good that the value improves with the value of inflation. or at least to produce better results than holding cash.

Of course, if you think the markets might collapse in the near future, it may be a good idea to hold cash to have the cash needed to take advantage of good deals.

Bullion is a bit of a different situation. It may be the only primary asset class that we believe is undervalued in this environment, perhaps the only asset class that the “everything bubble” has bypassed. This is an interesting phenomenon, given that bullion tends to perform very well in an environment of inflationary and negative real interest rates. It makes sense to hold at least a small percentage of your portfolio in bullion.

• For central banks, this means an increase in the concentration of gold reserves. In 1980, banks held more than 70% of their reserves in gold; by 2005, this percentage had fallen to less than 5%. It is now on the rise again.

• For individuals and businesses, rather than having negative interest rate instruments, bullion becomes more attractive.

We live in interesting times, as the saying goes. Investment strategies that have worked in an environment of low inflation and falling interest rates are unlikely to work in an environment of inflationary and negative real interest rates.

Disclaimer: This article is not intended to advise any investment decision, and no one will assume any responsibility for the information contained in this document.

Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (www.europhoenix.com), a Central European corporate finance company. He is a former global banker, author of Business Exit Planning (www.businessexitplanningbook.com) and former president of the American Chamber of Commerce in Hungary.

This article first appeared in the print issue of the Budapest Business Journal on September 24, 2021.

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