For those with an interest in the investment markets, low rates can be problematic, and unfortunately for all, they seem to be becoming an increasingly common feature in the current economic environment.
It is this that prompted Federal Reserve Vice Chairman Stanley Fischer to warn of their dangers in recent remarks to the Economic Club of New York, where he suggested that they can make the economy vulnerable by contributing to longer and deeper recessions.
For investors, this isn’t always a bad thing. Depending on your assets and the areas you’re investing in, low interest rates can actually boost some markets, thus generating increased wealth for traders who are managing to successfully play the trading game.
Equities are a perfect example of this. It is often held that low real rates can boost the equity market, and they do this by simple asset switching. Low rates on bonds and cash tend to make them less attractive, and where this is the case, equities start to hold a far greater attraction. As a result, investors flock to them, and the equity markets surge.
Not all markets react so positively, however. Here, we look at the areas where low interest rates could adversely affect your investments, so that you can always stay one step ahead…
Unlike equities, the stock markets are often adversely affected by low interest rates. Where these are prevalent within the domestic or global economy, they drive up the price of borrowing, and make raw materials cost more. Both of these factors eat into profit margins, and can significantly reduce them in the long-term, which in turn drives down stock prices.
As we mentioned above, low interest rates often have an adverse effect on bonds. The lower the figure, the less attractive they become to investors, as the returns they yield are simply not worth the investment. For many of the traders who shy away from, the reasoning is simple: far better to take a chance on the potential double-digit returns that areas like the stock market can produce, rather than tying up funds in less profitable ventures.
Unsurprisingly, indices react to low interest rates in much the same way as the stock markets they are based upon. Where interest rate figures reduce, companies often have to cut back on their growth spending, and tend to return a lower profit. This in turn reduces the price of their stock, and where this trend impacts enough companies, the whole market, and the indices that represent them, are dragged down in their turn.
The implication to be drawn from this is clear: interest rates matter, and if you want to continue investing successfully, you need to not only be aware of them, but also understand their impact on the various segments of the financial markets.