Interest rate cuts have lost their power to have any meaningful effect on economies, according to Columbia Threadneedle’s global chief investment officer, Colin Moore.
A day after the European Central Bank cut rates to record lows, and ahead of meetings of the Bank of England and US Federal Reserve, Moore says the Fed is largely helpless in stopping a US recession occurring: “10 years is long enough to see whether monetary policy can stimulate the economy on its own. It hasn’t happened now, why do we think it will happen going forward?”
The Federal Reserve is expected to cut interest rates next week by 25 basis points, following a cut in July. The u-turn in policy follows four small hikes in 2018 as part of what the market expected to be the start of a tightening cycle.
But there are mixed signals from policymakers about whether all of last year's rate rises will be reversed. “Now we’re really not sure what the Fed is telling us,” says Moore. He rejects the idea that rates “need” to go higher and notes that in previous recessions the Fed has got it wrong: for example raising rates, which chokes of the supply of money in the economy, just as companies start to struggle.
Changes to the working age population, as well as lower economic growth rates, mean that lower interest rates could be more suitable to current economic conditions. This chimes with the "lower for longer" mantra that has taken hold of financial markets in recent years.
Moore says company finance chiefs he speaks to don’t think borrowing costs are currently a problem. Economic policy changes are likely to have more of an effect than interest rates, he adds. US tax cuts are one an example, albeit a short-term one, of a policy intervention that boosted the economy.
The Fed has come under pressure from President Trump to cut rates to zero or even negative, from their current rate of between 2-2.25% now. After next week’s meeting, there are two FOMC meetings for the rest of the year, in October and December. US rates are significantly higher than in the UK, Japan and the eurozone, where the European Central Bank this week cut overnight deposit rates and re-started its quantitative easing programme after ending it at the end of 2018.
Recession – Short and Sharp?
On the topic of recession, Columbia Threadneedle’s model suggests a lower probability of a US recession than that forecast by the Federal Reserve.
Moore doesn’t expect a deep bear market, but expects lower stock market returns than in the last recession, with annual gains of around 4% for US markets. But there will be bouts of volatility along the way, he warns.
How can investors prepare themselves for a downturn? It's a topic we have discussed on Morningstar in recent weeks. "Lesson number one is to continue to invest," says Morningstar Investment Management's Dan Kemp.
“I’m not sure I would do anything different as an investor” if we get a short, shallow, two-quarter recession, Moore says. But if investors think there will be a deep, prolonged recession, they need to start planning now. Bond markets may be flashing warning signs at the moment, but they can send false signals, he adds. Columbia Threadneedle's global head of equities, William Davies, argues that the bond market is suggesting a 50% chance of recession, but that may be misleading.
The yield curve inverted recently, which means that long-term borrowing costs are lower than short-term ones. It's often seen as a harbinger of recession. The yield curve in the US and the UK has since gone back to its "normal shape", that is the two-year yield is lower than the 10-year.
Moore adds that investors shouldn't get too fixated on the yield curve given that there are so many other economic indicators to look at, for example the Purchasing Manager Indices (PMIs).
