Expected effects of long-term interest rates falling below the growth rate - Natixis

Patrick Artus, Research Analyst at Natixis, suggests that when long-term interest rates fall below the growth rate, the valuation of long-term assets (equities, real estate) becomes very uncertain.

Key Quotes

“In the absence of a risk premium, the value of these assets should tend to infinity, because the future income growth that they generate (dividends, rents) is higher than the discount rate. We want to determine whether the crossover between long-term interest rates and growth rates has indeed had this expected effect on asset prices, or whether risk premia have adjusted upward to offset the abnormal fall in long-term interest rates.”

“We find an upward impact on asset prices due to this crossover between long-term interest rates and the growth rate.”

“The long-term interest rate fell below the growth rate in 2010 in the United States, in 2012 in the United Kingdom, in 2013 in core euro-zone countries, in 2015 in peripheral euro-zone countries, and in 2013 in Japan. It can be expected that prices of long-term assets (equities, real estate) would increase sharply at those times.”

“This can be seen in the case of: - Equities in the United Kingdom, in the core euro zone, and in Japan; - Commercial real estate in the United States; residential real estate in the core euro zone and in Japan; i.e. in six out of 11 cases (in the United States, we look at commercial and residential real estate).”

“In the other cases, by construction, the rise in the risk premium offset the fall in the longterm interest rate. The peripheral euro-zone countries are a special case: asset prices there moved in line with those in the core countries in 2013-2014 although long-term interest rates were still high.”