Whither interest rates

Interest rates have been moving up. The question every year, for the last few years, has been is this the year that rates bounce back up from their historic lows.

Here is the graph from the Bank of Canada. Not a huge move, but definitely a tick up. Is this just noise or the start of a more meaningful move.

US Yields have shown a similar bounce up.

How much can we make of this? To be honest yields are now impossible to forecast. It used to be fairly easy in the past.

The yields on long Governments bonds used to be based on a number of factors that could be analyzed. Inflation expectations of bond vigilantes, Government deficits, other investment options, whether we were entering a boom (higher trending yields) or a bust (lower trending yields). 

Now however, things are so messed up that no one has any clue where they will be, and the many predictions of higher rates have been 100% wrong for the last 4 years.

We have so many unique things going on that the equation no longer works. 

First we have low inflation. Even though the Central banks have dropped rates to near zero and bought bad debt and Governments have ramped up spending, the inflation genie has NOT come out of the bottle. The velocity of money (the speed at which it passes through the highly indebted economies has slowed), Debt is still being unwound in the private sector (Canada has just started) and Governments have just realized they cannot borrow and spend indefinitely. Second we have an anemic job market and therefore low wage pressure. All in all not a recipe for inflation.

Secondly we have Central Banks like the Fed and the ECB buying their own Government bonds..huh? What sort of bizarre Capitalism is that? Like a company buying it's own products when no one else wants it. They have to keep interest rates low by whatever means it takes. 

Take the US, it is paying an astounding $360 Billion interest a year alone- when rates are near zero. Imagine what would happen if they went to 5% which is the historical average.

Finally we have two pressures pushing rates down. The first is fear of 2008/9. The sudden deleverage that took place had people fearing widespread defaults of large banking and industrial institutions. This was averted by zero rates and tax-payer infusions of money and assumption of liability - to a criminal degree IMVHO. The fear is still there however. 

Furthermore the Boomers are desperate for yield. 

Each $1M of savings will yield $15,000-20,000 a year in Canada from GICs and even less in the US. That's before tax and is not enough to sustain a retiree. Hence they will jump on any chance of juicing the yield up a little by moving into longer duration bonds or accepting more risk than they should.

There are literally Millions of people looking for safe, steady yield at a time when none is to be had.

So even though rates may have popped and moved off the bottom, there are very strong forces which are likely to keep them very low, for much longer than we think. We should not expect a 'rate shock' to be a major factor in any RE correction. We will have to get there on the basis of lack of affordability, reductions in Government inducements (stupidity), demographic changes and a change of psychology. 

In the US, Greenspan told everyone to go 'variable and not fixed in their mortgages' and then raised 16 times (yes it's true!) killing those who took his advice, and the result was a sudden bursting of the RE bubble, which could not be reflated when the FEd subsequently slashed rates. 

In Japan however, it happened without rates rising, just as a reaction to a decade of foolish over-pricing. We could follow Japan, rather than the US in this.
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Finally I noted some great links on Vancouver Condo- hat-tip VMD. These show the effect on demographics on our economy. The numbers are quite staggering

This graph shows us that from 2010 onwards we are a point where the number of non-workers being supported by workers is going up very rapidly and will soon be 50% higher than the 2010 number and eventually twice the number. 

How is that going to happen? The worker must either pay a lot more tax or the recipient must receive less OR we do neither and just borrow and leave it for the next generation to deal with, as the US and Europe have done.

This paper from the Bank of Canada is easy to read and is a must read.  Our Aging population means less taxes and more entitlements. $20K a year healthcare costs when we go over 80! Add in pensions and other subsidies,  then throw in the fact that Canadians have saved very little for retirement. Stir in the demographic  truth that the fastest growing group will be the over 80s and you can see we have a very hot stew in the making!