It is not unthinkable that long-term interest rates could double, while shares soar and fall again. After all, the Bank of England did not foresee the last market crash
It will be a year of disruption and we had better get used to it.
But it is easy to say that. What sort of disruption? Where should be look? Should we worry?
Start with economics, because for all its uncertainties it does follow certain patterns, whereas politics does not.
And start with where we are now: a solidly growing world economy and booming share markets, but a sense of foreboding nevertheless.
For people in Britain, the sense of foreboding has been sharpened by concerns about Brexit – though from an economic perspective these appear to have receded in recent weeks. The pound is at its highest level against the dollar since the Brexit vote. But those booming share markets are causing concern, not just in the UK but everywhere, and they contrast with a rather different sort of worry about bond markets.
Chris Watling, who runs the consultancy Longview Economics, puts it neatly:
“Two great stock market legends, Bill Miller and Jeremy Grantham, have expressed their view that it is ‘melt-up’ time in equities while the ‘bond kings’, Bill Gross and Jeffrey Gundlach, have pronounced confidently that the secular bear in bonds is confirmed!”
To clarify for people who don’t follow financial markets, the experts think that shares will shoot up this year, while bond prices will, if not slump, at least start a long downward slide. The argument behind this is that global growth will benefit the big companies that make up the share indices but also lead to a revival in inflation. That would force central banks to increase short-term interest rates faster than they currently plan, and if that happens, long-term rates will climb faster too. (Bond prices move inversely to long-term rates.)
Expressed like this, it all sounds reasonable and rational. But if you think about it, it could be very disruptive. Suppose shares do whizz on up for the next few months. We all know what happens then, because at some stage the climb gets out of hand and there is a crash. The higher shares go, the greater the fall. So this could turn out to be a year in two halves, with the peak in the late summer or early autumn. October is the classic month for sudden market dips, but it is pointless trying to predict – all we can do is to point to potential triggers for disruption.
For bonds it is a different form of disruption, and, to my mind, possibly a more damaging one.
Long-term interest rates have come up a little in recent weeks, but they are still very low by historical standards. The return on government bonds remains very low, but for most of us what matters is the rate we can borrow at, and this is still low, too. Indeed, for anyone borrowing on a mortgage in just about any developed country, rates remain close to the lowest they have ever been: not the lowest for 10 or 20 or 50 years, the lowest ever. Thus in the UK 10-year fixed rates are between 2.5 per cent and 3 per cent.
Now suppose rates double.
Unthinkable? Well, no. Go back 20 years. Base rates were 6 per cent and a mortgage around 7.5 per cent. True, the Bank of England has indicated that though rates will rise they will not climb to anything like the levels they were before the banking crisis. But the Bank does not have a crystal ball – it did not see the banking crash coming. While I don’t think there is any chance of interest rates doubling this year, it seems to me quite plausible this could happen in two or three years’ time. You can see the scope for disruption.
Now turn to the real economy. On a one-year view we can, I think, be reasonably relaxed. If the world economy keeps growing, that momentum pulls everyone along with it. As far as the UK is concerned, just as last year seems to have turned out rather better than most forecasters expected, with growth now estimated by the National Institute for Economic and Social Research at 1.8 per cent, growth this year should be reasonable too. But it would be naive not to acknowledge that the Brexit negotiations will be disruptive, and there must be some cost as a result of that.
The final area of disruption, politics aside, will be technology. My instinct here is that this will be a year of reassessment of the role of the technology giants. There is a bit of backlash going on against Uber and Facebook, for example, and that will continue. It is hard to see their roles reversing – you can imagine a world without Uber but one without Google or Facebook? – but there may be a redefining of the way these companies affect our lives. The high-tech revolution will roll on, but maybe head in a different direction.
The big point here is that we are at a transition point. The recovery from the 2008 slump is history. It has happened. The dominance of the high-tech giants has happened too. But many people are dissatisfied and uncomfortable, not just in the UK but also in the US, Europe and beyond. I think the main reason for that is an awareness that we are in flux. Disruption is not bad in itself but it is inevitably unsettling. Stand by for a disruptive year.