By Randy Myers
U.S. interest rates have been holding at or near historic lows for six years now. That is a long time, but it could be longer still before they climb much higher, says Matt Toms, Chief Investment Officer, Fixed Income, for Voya Investment Management.
Addressing the 2016 SVIA Fall Forum in October, Toms cited a litany of reasons to expect the current low-rate environment to persist. Chief among them are a slow-growing U.S. economy and low inflation. Against this backdrop, the Federal Reserve has maintained an accommodative stance on monetary policy. With growth also slow in Europe and Japan—and slowing in China—so have other central banks across the globe.
“We have a price-controlled world … and unfortunately there is no sign of this reversing,” Toms told his SVIA audience. “The Federal Reserve said at Jackson Hole that in response to the next recession they would cut interest rates up to 300 basis points and buy $2 trillion in securities. So the Fed has already told you its game plan for the next economic downturn, and it is more of government-controlled markets.”
Since the Fed has indicated it does not want to create negative interest rates, Toms added, its roadmap suggests it does not think short-term rates will move high enough between now and the next recession to allow a cut of more than 300 basis points.
Unlike some critics of Fed policy, Toms did not disparage the Fed’s decision to take an accommodative monetary stance after the 2008 financial crisis. In fact, he said, it was “great” for addressing the depression risks of that crisis. Since then, household debt as a percentage of GDP has improved. The U.S. consumer has deleveraged, adding some stability to the economic outlook. The unemployment rate has fallen from a crisis peak of 10 percent to about 5 percent. Household wealth has increased, and so has the savings rate. Equity markets have rebounded, as has the housing market. All that is good for those who own the country’s wealth, Toms said, but he also argued that Fed policy is now exacerbating the populist divide between the country’s haves and have nots. Those who have not been able to capitalize on low rates—by purchasing a house with a more affordable monthly payment, for example—are falling further behind.
The question now for the Fed, he said, is how long it should stick with its extraordinarily accommodative monetary policy. “Our punch line is, we’re staying too long,” he answered.
What finally could spur the economy onto a faster growth trajectory? Ultimately, Toms said, growth is a product of how many people are working and how productive they are. And the news is not very encouraging on these fronts. U.S. labor force growth has been trending lower for decades, while productivity growth has recently dipped below 1 percent. In this climate, the Fed is now anticipating economic growth of only 2 percent over the next four years, its least bullish outlook since at least 2011.
Despite the low rate environment and hence the low cost of money, Toms said companies are not funneling much into capital expenditures. Instead, they have been content to reward shareholders more immediately, with stock buybacks. The one bit of good news related to corporations’ unwillingness to leverage their balance sheets, he said, is that it should moderate the amplitude of the next economic downturn. However, Voya puts the probability of a recession anytime soon at only about 20 percent or less, he said, with most likely catalysts coming from outside the U.S.—a significant economic downturn in China, perhaps, or a further unwinding of the European Union, which the U.K. has already voted to leave.
In the meantime, Toms said, the impact of the Fed’s monetary policy on the economy is in decline while its impact on the financial markets is increasing. “We live more in fear of market volatility created by the Fed than we do in excitement about Fed economic activity improving the outlook for growth, which is different than what it was seven years ago. Said another way, it’s time to move on, central banks. You’ve already answered the crisis.”
Until that happens, Toms predicted that investors will look for attractive levels of income relative to the risk they take. His advice for fixed-income investors? “Look for those things that benefit from low rates,” he said. “Look for property values beyond your bonds—securitized markets, for example, versus corporate markets. It still takes an awful lot of diligence to determine which to buy, but ultimately that’s the tailwind that has been provided. Use it in markets like the non-agency market, the CMBS market, the CLO market, and the ABS market. We think there’s a tailwind there that may be underappreciated.”