What continued low interest rates mean for your finances
When central bankers around the world slashed interest rates to near zero after the financial crisis in 2008, everybody expected it to be a temporary measure.
Yet rather than lasting just a few months, low rates are still with us today and look set to remain low. Astonishingly, seven-and-a-half years after the great global interest rate cull they are still being slashed, with little sign of a reprieve.
The US Federal Reserve did take one tentative step in that direction with a single rate hike last December, but so far it hasn’t dared to repeat the experiment.
Elsewhere, central bankers have hacked at rates more than 55 times so far this year, with the Bank of England wielding the knife following Brexit. In Japan, Switzerland and the euro zone, interest rates are negative, something that would have been unthinkable a decade ago.
So what does that mean for our personal finance portfolios?
When the US Federal Reserve lifted rates to between 0.25 and 0.5 per cent in December, most analysts were predicting another four hikes in 2016, but so far there have been none.
Today, the most they expect is a single rate hike but many suspect the Fed will not even do this.
Josh Mahoney, market analyst at IG, which recently opened offices in Dubai, says minutes from the latest Federal Open Market Committee (FOMC) meeting show members remain split. “Markets have taken this as a sign that there may not be a rate hike in the remainder of this year.”
John Hardy, head of FX strategy at Saxo Bank, says it is increasingly likely the Fed will do nothing, while other central banks are easing as fast as they can. “The Bank of England has cut rates and restarted quantitative easing [QE], the European Central Bank may announce new measures in September, and Japan is also doing fiscal stimulus.”
Mr Hardy says this is a sign that the Fed is finally capitulating and won’t raise rates beyond one symbolic hike.
Sam Carleton, chartered investment manager at Arbuthnot Latham & Co, which advises expats in the UAE, expects interest rate expectations to remain “muted” for the foreseeable future. “As we analyse central bank policy across the world the overwhelming rhetoric supports further accommodative monetary policy.”
Low inflation is a key factor, with US consumer inflation running at just 0.9 per cent, and prices rising just 0.6 per cent in the UK and a meagre 0.2 per cent in the euro zone.
Traditionally, low interest rates would fuel inflation but companies around the world are reluctant to dip into their record cash piles because they lack confidence in future growth prospects. Cheap exports from China are also fuelling deflation, as is the country’s shrinking appetite for oil and other commodities.
Mr Carleton points out that US consumers, like many around the world, remain highly indebted and would be vulnerable to rising rates. Emerging markets that have borrowed heavily in US dollars would also be hit hard.
The world, it seems, cannot afford an interest rate hike. Analysts have unwittingly fallen into the habit of predicting rate hikes two or three years down the road and today they are talking about 2019 or 2020. There is a fair chance they will be proven wrong again.
Instead, the world seems to be following the lead set by Japan, where interest rates have stayed near zero for more than two decades, and counting.
Low interest rates are a mortal blow for cash, savaging the returns on savings and forcing people to invest in riskier stocks and shares instead.
It is now almost impossible to get more than a fraction of a percentage point on your savings. Even beating the current UAE inflation rate of running at 1.76 per cent in the year to June is proving tricky, eroding the value of savers’ money in real terms.
Mr Carleton says the danger is that share prices are now at inflated valuations, and current political risks, including Brexit and a Donald Trump presidency, will keep markets volatile well into next year.
Instead of investing directly into equities Mr Carleton favours targeted absolute return funds that invest in a blend of assets, including shares, cash, bonds, property and complex financial instruments such as derivatives, in a bid to provide a positive return even when markets are negative.
Adrian Lowcock, investment director at Architas in London, says absolute return funds can help to protect your capital while beating the returns on cash. “However, the sector has a reputation for high fees and complex investment strategies which are not clearly explained to individual investors, so there are no guarantees.”
Mr Lowcock adds that CF Odey Absolute Return is the top performing fund in the sector in the five years to July 21, returning 99 per cent, according to figures from Trustnet.com. City Financial Absolute Equity follows with 85 per cent growth while Argonaut Absolute Return grew 50 per cent. Remember, past performance is no guarantee of future returns.
Darius McDermott, managing director of Chelsea Financial Services in London, names three more funds that should benefit from low interest rates and government stimulus.
He tips Evenlode Income, which invests primarily in the UK and US and has risen 115 per cent over the past five years, and Standard Life Investments Global Equity Income, which targets an international spread of companies and returned 100 per cent over five years.
Mr McDermott suggests balancing this with a corporate bond fund and tips MI TwentyFour Dynamic Bond, which returned 46 per cent over five years.
Corporate bond funds invest in IOUs issued by companies and give you a blend of income and capital growth.
Tom Anderson, regulated investment adviser at Killik & Co in Dubai, tips Invesco-Perpetual Corporate Bond and M&G Corporate Bond, which have both returned around 40 per cent over the past five years. “Bonds are less risky than stocks and shares, but they are expensive these days and far from risk free.”
Record low interest rates have forced more investors into dividend paying stocks, which are disproportionately listed on the London FTSE 100, which yields an average of 3.5 per cent, against just 2 per cent on the S&P 500 in the US.
Mr Anderson says you can invest in the FTSE 100 with a low-cost tracker or exchange traded fund (ETF) such as iShares FTSE 100 but yields are never guaranteed with top companies like oil giant Royal Dutch Shell struggling to afford their dividends.
Another option for income seekers is the ProShares S&P 500 Dividend Aristocrats ETF, which tracks top US companies that have increased their dividends for at least 25 consecutive years, and currently yields 2.48 per cent a year.
Sam Instone, chief executive of AES International in Dubai, says if interest rates remain low the effect could reshape the world.
Negative interest rates mean you effectively pay the bank to look after your money, and there may be other unexpected results. “There may come a time when banks stop passing on lower borrowing costs to customers for fear their business model will collapse.”
Another danger is that governments may be overzealous in their borrowing in a bid to bribe voters, storing up more debt, Mr Instone warns.
He says the only thing you can do is block out the “noise” and focus on your personal financial goals. “Even the professionals cannot say what will happen next with any accuracy so don’t hang on their every prediction.”
Invest in a balanced spread of assets that reflect your attitude to risk – shares, bonds, property and cash – and stick to it for the long term. “Don’t take fright and do something rash like piling everything into gold or emerging market bonds,” he urges.
Mr Instone adds that everybody should abide by the following four simple financial planning rules: “Stock markets will rise over the long term. Bonds are less volatile and offer important balance. Property can be excellent, especially if you want to live in it. Finally you should always have enough spare cash to keep you going for a few months if something goes wrong.”
Consider seeking advice from a qualified, regulated independent financial adviser or chartered financial planner. “They should have your best interests at heart, rather than trying to sell you products to earn commission,” Mr Instone adds.
Beating today’s low interest rates isn’t easy and the challenge will only intensify until rates finally start rising. Whenever that is.
The effect on property
More than seven years of low interest rates have encouraged property buyers to load up on cheap debt and chase prices higher, but this has left many vulnerable to higher borrowing costs or a crash.
Faisal Durrani, partner and head of research at property company Cluttons, says low interest rates signify a global economy that has failed to achieve escape velocity in the years since the financial crisis. “We continue to hit fresh bumps in the road in the form of the slowing Chinese economy, the collapse in oil prices and Brexit.”
Villa and apartment prices in Dubai and Abu Dhabi fell between 4 per cent and 6 per cent during the second quarter, compared to the same period last year, according to property consultants Cavendish Maxwell.
Mr Durrani says demand and transaction levels have been hit by falling oil prices, but this may be a good thing after years of record growth. “For Abu Dhabi, the effect is likely to linger for longer given the emirate’s higher reliance on hydrocarbon receipts, while in Dubai, the looming Expo 2020 is likely to spell a turnaround in the fortunes of the property market as the mega event draws nearer.”
Richard Bradstock, director for the Middle East, at property company IP Global, says safe haven property markets, including post-Brexit UK, continue to offer steady capital growth and regular yields. “Low interest rates are positive for property markets as this drives down borrowers’ costs.”
Mr Bradstock says they will continue to drive the UAE market, especially given low returns on other assets. “This should assist a move into a positive growth cycle in the latter half of the year.”
A global property crash remains unlikely while interest rates are low but almost inevitable if rates rise sharply. On current trends, that could be many years away.
Follow The National’s Business section on Twitter
Updated: August 26, 2016 04:00 AM