The prolonged period of low interest warned Central Banks about global growth. Here we explain why.
In 2008/9, the world went through the worst financial crisis of our time. The crisis was caused mostly because of the increase of subprime lending to people who were not able to pay back the mortgages. As the prices of houses started to decline, these people found themselves unable to pay their mortgages.
This led to the sharp increase in redundancies, which led to the ultimate collapse of big banks like Lehman Brothers and Bear Sterns.
After the crisis, the world underwent an expansion, that is now the longest in history. This expansion was helped by the prolonged period of low interest rates and other monetary policy decisions such as quantitative easing, also known as the QE.
The QE is a process in which the central bank buys large amount of assets such as government bonds in a bid to supply money to the economy. This led to a massive expansion of the Federal Reserve balance sheet, which has expanded from about $1 trillion to more than $4 trillion.
Other central banks like the European Central Bank (ECB) and Bank of Japan (BOJ) combined the quantitative easing with negative interest rates.
→ Monetary Policy: How the Central Bank Works
The rise of Debt
Buoyed with the long period of easy money, companies and individuals in the developed world increased their debt appetite. Today, in the United States, corporations hold more than $9 trillion in debt. Around the world, corporate debt stands at three times the GDP. The need for returns for shareholders has fueled the intake of this debt.
This is because corporations have been forced to continue paying a hefty dividend and increase their share buybacks.
Indeed, in 2018 alone, companies awarded their investors with share buybacks worth more than $1 trillion as they celebrated one year under the Trump tax cuts.
It seems that the celebration will not last long. This is because the probability of a slowdown in the global economy has increased significantly in the past few months. Last year, International Monetary Fund (IMF) issued a report downgrading the global economy.
This year, the downgrades have continued to come. Last week, the Reserve Bank of Australia, ECB, and Bank of England all downgraded the outlook of their respective economies. In the previous week, the Federal Reserve released its monetary policy statement saying that the global economy continues to face headwinds.
As a result, the bank announced that it would pause its interest rates hikes.
Therefore, with the risks to global growth rising, and with central banks preparing to end the prolonged period of low interest rates, there are higher chances that a major market activity will come.
It is impossible to accurately predict when this activity – crash – will happen. However, risks are already being seen. For example, the yield curve is close to inversion and corporate earnings are showing signs of slowing down.
All this presents a major risk to investors who buy and hold their portfolios for a long time.
For traders, you just need to be careful, limit the volumes of your trades, and always have a stop loss. A trailing stop loss enables you to lock up the profits in case of a reversion.
→ The importance of Stop Loss