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Why rates could stay low no matter what the Fed does

While Fed Chair Janet Yellen and Vice Chair Stanley Fischer recently hinted that another rate hike is likely sometime by the end of the year, low interest rates may be here for the long run irrespective of Fed action.

Lower rates are not just the result of central banks buying billions of dollars worth of bonds over the years in the United States, Europe, and Japan, according to Brian Barnier, head of research at ValueBridge Partners and founder of FedDashboard.com.

Household & Nonprofit Financials / Disposable Personal Income
Household & Nonprofit Financials / Disposable Personal Income

“There’s more cash in the world and less need for cash in production,” he said. Relative to disposable personal income, household and nonprofit cash holdings are up since the 1990s. But in the past decade, debt’s share of personal income has steadily decreased.

Slide3
Slide3

However, that cash isn’t being used directly to fund the private sector, Barnier claims.

“Textbook economics says households and nonprofits are supposed to be funding business but that’s not what’s in the data,” he said. “For a long time, it’s come down but now we’re picking up cash in the non-financial business sector relative to their gross value added or GDP or their production. So they’re throwing off cash at the same time households have more cash. That’s a lot more cash that’s driving down the natural interest rate.”

Slide4
Slide4

And although cash is on the rise, prices haven’t followed suit. “Cash is going up but costs of production are falling,” Barnier said.

Property, plant, and equipment costs have declined relative to GDP over the past few decades as technology decreases the need for a large real estate footprint and shrinks the size of machines needed in manufacturing. Labor’s share of GDP has also fallen since the start of the millennium.

“That’s also why you’re seeing some of those lower prices out there,” he added.

Investors need to accept the idea that lower notional rates will be in place for a while, said Barnier. “Prepare your portfolio in a very different way than you have been in the past,” he recommended.