Is the Stock Market for Real or Just Addicted to Low Interest Rates and Easy Money?

Federal Reserve chairman Jerome Powell indicated in Congressional hearings on Wednesday that the Fed could be cutting its benchmark interest rate later this month – and the stock market promptly went up.  So, a “Powell Put”?  (See here.) 

In addition to a possible U.S. rate cut, interest rates in Europe remains at historic lows.  The European Central Bank’s rate for overnight deposits by banks is -0.4% (where it has been for over three years), which means you would get back less than you put in.  In June, five-year bonds issued by mortgage banks in Germany were priced at -0.2%, which means you would have to pay the bank in order to lend them money.¹  And in Denmark some banks are even offering mortgages at negative rates,¹ which means … well, you get the idea.

But even though interest rates are down (and stock prices rising), borrowing doesn’t seem to be up, at least as much as the lower interest rates would suggest.  In March, The Wall Street Journal said:

“When it comes to liquidity, central banks can bring the horse to water but can’t make it drink. …

Banks’ lending decisions are mostly made on the basis of how creditworthy their borrowers are, not the availability of funds.”

It also depends on whether companies actually want to borrow, regardless of the rate.  No matter how low the rate is, if potential borrowers don’t have confidence in future growth, they’re not going to borrow.

Still, as Gillian Tett said in the Financial Times:

“[I]nvestors, economists, and policymakers are increasingly pointing to long-term structural explanations for the shift to negative rates. …

The bottom line is this: the more that the economic consensus quietly starts to attribute negative rates to structural issues, … the more likely they are to assume this pattern is here to stay. …

[I]t leaves investors and public institutions exposed to nasty potential issues if rates suddenly rise ….

[P]oliticians and investors need to talk about this growing risk – and retain their sense of imagination in this Alice in Wonderland world.”¹

This is especially true to the extent low interest rates are supporting the stock market valuations and rises in wealth we see today.  It seems almost like an addiction, with stock markets getting high on low rates and easy money.² 

Which raises the question: What if low rates aren’t the new norm. and what if our stock market wealth really is based on a kind of addiction to artificially low rates.  Can we keep up the doses of low interest rates and easy money to avoid a crash?  Of course, ultimately, we can’t.  It will come to an end, but we’re not going to know when or how it will happen.  But when it does happen, the withdrawal pains could make the 2008-09 global financial crisis look like a Sunday School picnic.³  And one wonders if those in charge (consider some of the possibilities today) will know what to do?
---------
¹ Gillian Tett, “Negative rates take markets into surreal territory,” Financial Times, June 28, 2019 (paywalled).
² Rana Forobar, “The allure of financial tricks is fading,” Financial Times, March 4. 2019. (paywalled)
³ Assuming it is politically correct to talk about a “Sunday School” picnic anymore.  Also, for a story of what addiction and withdrawal can mean, I refer to a movie, “Christiane F.”  It is in German, but it has English subtitles.  I shudder to think of the economy going through that.