Experiments in Negative Real Rates Tend to Lead to Excess….

Interesting commentary from David Rosenberg here regarding negative real rates and the tendency for excess to occur.  I’d say this time is slightly different in that the low real rates of the past tend to coincide with better credit conditions, but this time might find a different enabler in QE’s supposed “wealth effect”.  Here’s Fed Governor Jeremy Stein first:

“For example, a prolonged period of low interest rates, of the sort we are experiencing today, can create incentives for agents to take on greater duration or credit risks, or to employ additional financial leverage, in an effort to “reach for yield.” An insurance company that has offered guaranteed minimum rates of return on some of its products might find its solvency threatened by a long stretch of low rates and feel compelled to take on added risk. A similar logic applies to a bank whose net interest margins are under pressure because low rates erode the profitability of its deposit-taking franchise.

Moreover, these three factors may interact with one another. For example, if low interest rates increase the demand by agents to engage in below-the-radar forms of risk-taking, this demand may prompt innovations that facilitate this sort of risk-taking.”

And then Rosie:

“as the charts below illustrate, it may take time to fester, but each period of real zero or sub-zero real interest rates ushered in by the Fed in recent cycles generated bubbles somewhere.  And they don’t tend to end very well.  Store that in your pocket for future reference.”

Hard to argue with this one. The Fed has been on a strategy of boom/bust cycles for the last 25 years that tends to target some form of nominal wealth with the presumption that this will help generate real sustained wealth.  It might accomplish that to some degree, but it appears to come with a price that includes a huge amount of economic volatility….


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Mike

    “It might accomplish that to some degree, but it appears to come with a price that includes a huge amount of economic volatility….”

    Agreed. Moreover, all the wealth created in these cycles has ended up in fewer and fewer hands. So, not only does the fed create short-lived distortions, it effectively acts as a change agent promoting wealth inequality. What a mess.

  • Jerry Khachoyan (@TheArmoTrader)

    Not saying that low interest rates cannot fuel bubbles, but I think this is a classic case of “one-bit analysis”.
    As in, here’s my one bit of data that shows my analysis is right.

    Again, not saying it didn’t or it can’t help. But we just need to realize that the economy is more complex than that.

  • jt26

    Any chance we could actually read the axes of the figure?

  • Skateman

    Japan’s had near zero interest rates for years now. Where’s their bubble?

  • http://tokyomacrochat.blogspot.jp/ nihonkaidanji

    Chuck Prince’s 2007 remark still applies today to us fixed income investors. “As long as the music is playing, you’ve got to get up and dance”. And as a Japanese investor I tend to see “low for longer” to persist for time being – longer than how the market scaled back recently…

  • Matt McOsker

    Do interest rates cause the bubbles or does private borrowing resulting from deficits that are too small combined with low rates cause the bubbles.

  • http://www.orcamgroup.com Cullen Roche

    Yeah, hard to get the bubble without credit growth. Though the surge in NYSE margin debt might be enough….

  • Boston Larry

    The low real interest rates represent an irresistable temptation for hedge funds and speculators to use leverage or margin debt to boost their investment returns. It also encourages speculators to chase after some of the riskiest assets. In 1999 it was tech stocks, during 2004 thru 2007 it was housing, and also financial stocks that were so tightly connected to housing. It is never as easy to see the next or current bubble as to look back and see previous ones.

  • http://www.nowandfutures.com bart
  • http://www.nowandfutures.com bart

    Most recent Z1 YoY credit growth around 4%, up from -2% 1Q 2010.

    Non financial sector YoY credit growth 4.8%… and it never went negative.

  • jaymaster

    Sounds like these guys have been reading some Minsky….

  • Mr. Market

    1. In other words “Stop with QE”.
    2. And what about the current bubble in US T-bonds ?
    3. This assumes the FED is in control of interest rates and the FED isn’t.

  • Oilfield Trash


    Ashwin also is of the opinion that negative real rates are dangerous.


    “Large negative real rates rarely incentivise those with access to cheap borrowing to invest in businesses. After all, why bother with building a business when borrowing and buying a house can make you rich?”

    “If the “danger” from macroeconomic policy is defined as the possibility of a rapid and spiralling loss of value in money, then negative real rates are far more dangerous than helicopter money.”