Five years into the equity bull market, global GDP growth remains sluggish, but it is expected to accelerate in the second half of this year. Yet benchmark interest rates remain close to zero and market interest rates are much lower than their long-run averages, thanks to unprecedented quantitative easing measures implemented by the Federal Reserve, Bank of England, and Bank of Japan during and immediately following the global financial crisis. Credit Suisse’s Jonathan Wilmot, founding partner of Credit Suisse Asset Management Systematic Allocation Strategies and former Chief Global Strategist at Credit Suisse Investment Bank, has a name for this kind of lopsided recovery: Reflation, which he defines as a period during which nominal and real GDP growth accelerates, but short- and long-term interest rates remain lower than is typical during an economic expansion. Policymakers, whose slashing of rates to almost zero saved the world economy from collapse, want them to remain low a little longer to help bring about a return to full employment and the orderly completion of a deleveraging process that has been underway since the crisis. While many are calling for a spike in rates any day now, Wilmot says that the economic state of reflation tends not to be short-lived. Even if rates jump in the short term, they will quite likely remain below their historical averages for longer than many investors expect.
Navigating Reflation: Just How Long Will Below-Average Interest Rates Be With Us?
Reflation isn’t going to be with us just for another few years – it may be with us for a decade or more.Watch the clip.
The Historic Precedent for Reflation
The global economy has been through reflation before. What lesson can we learn from those periods? If the bond market remains relatively subdued in response to improving economic data, corporate profit growth could continue to be strong and equities could continue their outperformance relative to fixed income for several years or more.
This is only the third time in the last 150 years or so that both short and long-term interest rates have been so low. In the aftermath of both the previous episodes, it took a very long time for interest rates and bond yields to normalize.Watch the clip.
Going Forward: Two Possible Scenarios
Wilmot sees two possible scenarios for the world economy. In the first, rates stay low even as the economy continues to improve. That would be both good for the economic recovery and for equities, and would give the equity bull market a little more juice. In the second, the bond market rebels, and rates go higher despite central bankers’ attempts to hold them down. That would be bearish for both the global economy and for equities. Wilmot thinks the first is more likely.