Negative Real Rates Aren’t Reversing Anytime Soon: Paul Podolsky

Money has flowed into the economy in a short period of time without sparking inflation or causing real rates to rise and should open the door to more aggressive fiscal action.

(Bloomberg Opinion) — The collapse in real interest rates to below zero means the U.S. government is being paid to borrow and spend. This is obviously rare, but that doesn’t mean the situation will soon reverse. Absent a low probability event like mass civil unrest or a balance of payments crisis, about the only thing could spur real rates to turn positive would be a massive infrastructure plan by the government.

Now would seem an ideal time for the government to borrow and spend to fix the nation’s increasingly creaky infrastructure. The World Economic Forum ranks the U.S. 13th in the world in terms of the quality of infrastructure, well behind places like Singapore, Switzerland and Germany. But although there is bi-partisan support for additional infrastructure spending, plans put forth by both Republicans and Democrats are too small to move the needle in terms of boosting economic growth by enough to meaningfully push real interest rates, or those after accounting for inflation, back above zero.

This has enormous implications for financial markets. Declining real rates have been the tail wind behind the 40-year upswing in the stock market. Real rates, especially those at the longer end of the yield curve, are a key factor for investors in determining the appropriate price-to-earnings ratio for equities. In short, the lower the real rate, the higher the ratio investors should be willing to accept. But should real rates rise, asset markets will need to re-price, potentially demolishing popular bets like those on technology stocks, gold and illiquid credit assets.

Although tighter coordination between fiscal and monetary policy coordination make it much easier to pull off a big infrastructure program, I’m betting the government is too timid take advantage of the remarkable opportunity in negative real rates. As a result, I’m sticking with an asset allocation that benefits from real rates staying low or even becoming more negative.

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