Another Year Near Zero?
For almost seven years, the world has been in a monetary state of emergency, with the largest developed nations' central banks holding interest rates near zero in an effort to jolt economies out of the doldrums. Increasingly, markets are acting as though this bizarre situation will last a while longer -- and that's a troubling sign.
For much of 2015, the dominant question among investors has been when the U.S. Federal Reserve, encouraged by economic recovery, will start pulling back stimulus by raising rates from zero. Lately, though, a different narrative has been creeping in: What if the slowdown in China and other emerging markets becomes a bigger deal, pulling the rest of the world down with it? Will the Fed and other central banks be able to raise rates at all?
One place to see the growing doubts is in futures markets, where traders bet on the trajectory of the Fed's short-term interest-rate target. Not long ago, pretty much nobody thought that the Fed would be at zero a year from now. As of Friday afternoon, futures prices implied a probability of more than 11 percent of such an outcome -- still low, but too high to ignore. Here's how that looks:
The picture is similar in the euro area, the U.K. and Japan: Expectations for where short-term interest rates will be in September 2016 have declined a lot. Options markets now see rates at negative 0.05 percent in the euro area, 0.81 percent in the U.K. and 0.10 percent in Japan. Here's a chart showing the euro area and Japan:
And here's a chart for the U.K.:
In this context, stock-market selloffs make a lot of sense. Even a small chance of a new global recession represents a significant risk. With rates already near zero, central banks would struggle to respond -- at best, they would have to resort to more quantitative easing, or to new and untested measures. And with developed-nation governments already heavily indebted and politically constrained, it's hard to see who else could come to the rescue.
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