3rd September 2020
Sometimes the most important news is also the most boring- but spotting it can be hard.
This is particularly true this Summer. It is hard not to focus upon the day to day ups and downs of this pandemic and the light and noise that explodes out of a US presidential race (particularly one including an embattled and enraged Donald Trump).
However, presidents come and go and ultimately this pandemic will pass too. Yet in the midst of it all we have seen at least two decisions made that could shape our world for a generation to come.
The first comes from Europe and we have written about it previously. As European nations battled the economic fallout of the crisis they finally agreed to issue European-wide debt. This marked a massive step towards burden sharing across the European continent. In essence a step towards a United States of Europe.
In time that move may prove definitive and shape the way power, wealth and responsibility is distributed around the world for decades to come.
The second came in the form of a technocratic speech last week virtually delivered by the chairman of the Federal Reserve Jerome Powell. The Federal Reserve is not just America’s central bank. In the midst of the violent financial moves seen as the virus bit, it was the institution which effectively back-stopped the whole global financial market.
Last week Powell announced a series of changes to the way the bank will think about interest rates for years to come. It has concluded that the ‘equilibrium’ interest rate (in essence the average rate that we all move around throughout the economic cycle) is around half what it thought it was – 2% rather than 4%.
It has also concluded that if there is inflation the bank should look through it and not tighten rates just because it has gone above its target.
Finally, it has said that it will no longer take full employment in the United States as a signal to tighten interest rates. Or in other words, interest rates are staying very low for a very long time and are unlikely to rise even if some inflation is produced.
This move plays into the fundamental positioning of your investment portfolio. We have long argued that central banks will keep rates ultra low for years to come in order to limit the damage down by the enormous debt built up by governments. This has reinforced that view.
Your portfolio is positioned to benefit from this trend. Ultimately very low rates should lead growth-focused companies to rise in price and make it hard to make very much money from conventional government bonds.
In the short-term these pieces of news have had the effect of contributing to a weakening dollar against the pound and a strengthening Euro against the pound. This does not help our portfolios, in particular because UK shares tend to fall when the pound is getting stronger. A stronger pound reduces the value of the overseas earnings of UK companies. However, this is likely to prove a short-lived phenomenon.
It may not make the news when there are riots to look at and Donald Trump posturing in front of the White House. Yet these technical changes could well be the most powerful legacy of this crisis.
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