The real story behind low interest rates

The outlook for historically low interest rates is a top issue for investors. Low rates stem from tepid potential growth and central bank success in achieving predictable, stable inflation. Yet another critical factor is often overlooked in explanations of low interest rates: a structural rise in risk aversion and savings over the past two decades. We believe a step-up in risk aversion has led to a structural rise in precautionary savings, further dragging down bond yields across the curve—a trend that won’t quickly change, as we write in our Global macro outlook The safety premium driving low rates.

The neutral rate—which anchors the level of the entire yield curve—is a useful starting point for understanding what’s driving low interest rates. Textbook economics indicates that r* (the neutral rate) is determined not just by potential growth but by perceived risk, too. A persistent rise in risk aversion has raised precautionary savings, suppressing the neutral rate and other rates further out the curve. We believe this has been a critical factor behind the multi-decade drop in global yields, beyond the more familiar decline in potential growth as societies age, productivity softens and central bank inflation targeting keeps price volatility in check.

In the early 2000s, a major shift happened at the sovereign level: Asian economies, scarred by the region’s 1997–98 crisis of collapsing currency pegs, started building up big piles of foreign reserves to shield themselves against potential capital outflows in the future. China’s trade surpluses and household savings added to this surge in savings. Former Federal Reserve Chairman Ben Bernanke called this surge in precautionary savings the global savings glut. Since then, savings accumulation shifted from Asia to other regions—notably Germany and the eurozone, partly in response to the sovereign crisis.

Global risk aversion was initially stoked after the late-1990s Asia crisis and then it was magnified by the 2007–08 global financial crisis. These severe shocks motivated persistently higher precautionary savings by public and private sectors, dragging down the neutral rate. Our estimates suggest that greater risk aversion and lower potential growth each account equally for the roughly 150 basis point decline in the U.S. r* since the global crisis.

Neutral rates and risk aversion are not directly observable and may seem like the economics’ equivalent of dark matter. Plenty of uncertainty shrouds these estimates. Yet like dark matter their existence can be detected by their effects on other variables—and their impact is real, with concrete implications for the global economy and asset prices.

Risk aversion has clear and significant effects on the macro economy. Global savings are elevated and still rising. Gross global savings amount to nearly 26% of the $75 trillion in gross domestic product (GDP) (nominal as of 2016)—and that share has steadily climbed since the crisis. See the Gauging the glut chart below.

The chart also shows the GDP-weighted term premium for G3 (the U.S., Germany and Japan) economies: The linkages with global savings are surprisingly strong. How this global savings plays out will be a long-running—and much slower moving—story shaping interest rates and term premia.

Our bottom line: Persistent risk aversion not only suppresses rates across the yield curve but raises the premium on assets seen as the most safe and liquid. The resulting demand for highly liquid assets deemed safe is likely to keep rates historically low. Changes in perceived risk can jolt markets out of the current high risk aversion regime and lift rates. Yet we think this is unlikely. Record-high world debt stocks make various economic actors more vulnerable, motivating greater savings as a buffer against future shocks. Read more in the full Global macro outlook.

Jean Boivin, PhD, is head of economic and markets research at the BlackRock Investment Institute. He is a regular contributor to The Blog.

Read the BlackRock Investment Institute’s 2018 Investment Outlook to uncover the three themes we believe will shape markets in the year ahead.

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