The era of „cheap money” is over - July 29, 2018

The era of „cheap money” is over

In 2018 global markets reached an important milestone. As the most important central banks stop their large-scale asset purchasing (QE) programmes, it seems that the era of cheap money is over. In the meanwhile, shortage of labour, wage inflation, and general inflation are also appearing. This means that we can expect higher rates, tighter monetary policies. Government bonds can also become more important to investors.

We wrote about it several times that after the financial crisis of 2008, central banks started to decrease rates to or close to zero. They also started QE programmes to stabilize the economy and the markets. But this lead to a problem: markets, companies, and governments got used to the idyllic state of cheap (almost free) financing. After a while, this becomes counterproductive.

Low rates are hurtful

As we’ve underlined it several times before: rates around 0% are hurtful, while a general rate around 2% is the ideal rate for the global economy. The reason is that after a certain point, people don’t want to spend and consume more. They want decent savings and investments. But when rates are around 0%, they can only do that by taking risks. People started to choose risky bonds, stocks, illiquid real estates. This is also the reason why cryptocurrencies were so popular in the last years, although they have been losing their fanbase lately.

While central banks were trying to revive economy after the crisis, they made some other mistakes, too. They created a bubble on the financial markets. If this bubble bursts, that can lead to a recession. There is another serious problem: these policies created social discontent which helped radical political movements to gain ground around the world.

Fed started the hikes

American Federal Reserve Bank luckily started to end this spiral at the end of 2015. Ever since then, they hiked in seven steps which pushed the rates up to 1.75-2.00%. Other central banks are not yet ready to tighten up their monetary policies, but they can’t avoid their destiny forever. Ever since the crisis, the world’s 6 biggest central banks pumped no less than $18 thousand billion into the economy. These economic stimulants are going to run out until the middle of 2019 as central banks stop their QE programmes. This means that flooding the markets with cheap money is over.

Total assets of the main central banks

Click on the image to see it in full resolution

What’s more, in 2019 countries of the eurozone may also start to hike rates. The hikes of the Fed alone, however, can make money more expensive and may slow down some economies. Hiking the rate of the “world’s most famous money” will lead to more expensive money everywhere on the globe, thus ending the era of cheap money. (Moreover, before every recession, tighter monetary policies were put in place ever since the ‘70s.)

Bonds will be more important

The processes mentioned above accompanied by inflation have a great effect on the government bond markets. In the last 2 years, the prices of US bonds fell considerably, and that influenced global bond markets. It’s important to mention that US bonds were in an upward trend for more than 30 years and reached two-digit returns in the last years thanks to the rate cuts of central banks. (Since falling rates make state bonds more expensive and vice versa.)

Returns of 10-year US government bonds between 1970-2018

Lately, the 10-year US government bonds have a return around 3%, which can be considered as a risk-free return. This also means that money pouring into government bonds wouldn’t be surprising at all. These bonds may have a very important part in investment portfolios again, next to carefully chosen stocks. Bonds, however, still have a long way to go, since other developed countries still have super low (or negative) returns. In the next months (after rates are globally normalized) government bonds may be even more attractive.

Stock markets also sense this change, but there were no drastic movements so far. From the beginning of the year, there was a correction (which we expected), but markets are back on their feet. Higher volatility on the stock markets may remain, but that’s considered normal with stocks and what we’ve seen in the last years was indeed unconventional. We still can’t say that stock markets peaked. After the correction it’s very well possible that prices will reach new heights in the next 1 or 2 years. But that may be the last period of euphory on the stock markets, and bonds will have a more important part in the future of investing.

Disclaimer: This analysis is for general information and is not a recommendation to sell or buy any instrument. Since every investment holds some risk, our main business policy is based on diversification to minimize threats and maximize profits. Innovative Securities’ Profit Max has a diversified portfolio, which contains liquid instruments. This way, our clients can maintain liquidity, while achieving their personal investment goals on the long term.