Why slow growth and low inflation could mean persistent low rates

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Nov. 26 2019, Updated 9:49 p.m. ET

In my latest Market Perspectives paper, Under Pressure: Why Interest Rates Could Stay Low for a Long Time, I examine three reasons that play into this conundrum.

Slow growth and no inflation. Long-term rates tend to correlate with nominal growth (inflation plus real growth) which has been below trend since 2000. I believe that the deceleration in nominal growth has mostly been driven by secular factors, including slower growth in the labor force due to changing demographics and slowing productivity. And these factors are likely to remain in place in the coming years. To the extent that both real growth and inflation in the United States remain suppressed, both nominal growth and interest rates are likely to remain below the post-World War II norm.

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Market Realist – According to BlackRock, the gross domestic product (or GDP) growth rate for the U.S. has been averaging between 7% and 8% for most of the period after World War II. A drastic drop in growth rates came after the U.S. technology (XLK) bubble burst in 2000. The U.S. economy hasn’t regained the 7% nominal GDP growth rate since then. U.S. bonds (or BND) and Treasuries’ (TLT) yields fell with the nominal growth rate in the last decade. The advance estimate for 3Q14 GDP came in at 3.5%—lower than the second quarter level of 4.6%.

bond yields and nominal GDP growth

Market Realist – The graph above shows how the long-term rates have historically tended to correlate with the nominal GDP growth rate of the G4—the U.S. (SPY), Germany (EWG), Japan (or EWJ), and the United Kingdom (or EWU). This seems to indicate that slow growth combined with low inflation will likely keep interest rates low in the future.

PCE, CPI

Market Realist – The graph above shows the consumer price index (or CPI) and personal consumption expenditure price index (or PCE). These inflation measures stayed persistently low in 2014.

Although recent concerns about deflation have mainly been associated with the Eurozone (EZU), recent trends in U.S. inflation suggest that the U.S. is also being affected by this global phenomenon. The low inflationary trends resulted in a decrease in U.S. inflation expectations since August.

In the next part of the series, we’ll discuss how the U.S. population’s changing demographics will likely impact yields in the future.

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