Managing wealth in an era of low interest rates

As the world economy emerges from the Covid-19 crisis, financial markets are starting to get anxious. For most of the past year, investors had been reassured by central banks’ support, which included cutting interest rates to near zero and massive purchases of government bonds. Everything changed with the successful roll-out of vaccinations and Joe Biden’s stimulus plans. The stage was set for a strong economic rebound and the withdrawal of firefighting monetary policy measures.

This is where we are today. As with any sudden change in an established market trend, this one caused significant tremors. Bond yields – the measure of the income they pay relative to their price – have risen sharply. Expectations of higher inflation are now causing some concern. Could central banks change their stance much sooner than expected? Could the almost unthinkable happen, and interest rates rise?

Take a step back, however, and this year’s rise in bond yields looks like little more than a blip in an incredible 40-year grind lower. Even after its recent moves, the 10-year US government bond – a key benchmark for financial markets – yields just 1.7%. A decade ago, as the world recovered from the financial crisis of 2008, US yields were twice that. Before the crisis, they were often closer to 6% and at the beginning of my working career they were yielding almost 10%.

This doesn’t yet look like the end of a trend

10-Year treasury yield over the last 40 years

^{Source: Federal Reserve Bank of St. Louis}

Interest rates on deposits, which follow central bank’s interest rate decisions, remain at rock-bottom levels. “The economy is a long way from our goals, and it is likely to take some time for substantial further progress to be achieved,” said Jerome Powell, Chairman of the Federal Reserve, in April 2021. With US unemployment still above 6% – compared to 3.5% before the pandemic hit – there is a way to go before the US central bank even starts thinking about raising interest rates. It’s a similar story at major central banks in other developed markets, such as the UK and Germany.

Lingering concern about Covid-19 also ensures strong demand for safe havens like government bonds, helping to keep yields low.

While there is scope for yields to rise modestly from current levels, we think a number of longer-term factors will keep interest rates and bond yields anchored at low levels. These factors existed before the pandemic – and appear set to continue.

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