The Trouble with QE and Ultra Low Rates
From Euclid Advisors’ international investment team
Central banks are pushing interest rates to record low levels in order to encourage investment and subsidize economic growth. Trouble is, this is actually having the opposite effect, not only because of the market psychology these low rates evoke (“if it seems too good to be true, it probably is”) but because the foundations of our global economic/financial systems are being hollowed out by financial institutions themselves.
Banks and insurance companies play an integral role in the financing of economic growth. To do this, they must have strong balance sheets, but they must also have proper incentives to finance long-term, risk-adjusted economic investments, including homes, infrastructure, factories, and other growth drivers. With the advent of low rates, these incentives are no longer in place. So banks that cannot earn sufficient net interest margins will not lend. Insurance companies that cannot earn sufficient returns on their long-term assets won’t accept the long-term risks of their liabilities. And when banks and insurers aren’t able to function profitably, this puts the whole financial system at risk.
The consequences of low rates are only just starting to come into focus. What’s clear is they present new challenges for an industry already dealing with regulatory pressures brought about by the Great Financial Crisis. For the time being, we continue to take a “wait and see” approach, maintaining low exposure to financials and a higher cash position, until we are comfortable venturing back into the space.