3 Drivers for Low Interest Rates In The Future

It’s not a secret that the US and Singapore (and many other parts of the world) have been in a low interest rate environment for many years.

In a recent essay, Federal Reserve Bank of San Francisco President John Williams laid out three reasons why interest rates in the US and elsewhere have stayed low and “are going to stay lower than we’ve come to expect in the past.”

The Federal Reserve is the central bank of the US. Interest rates in Singapore are linked to what’s going on in the US, so developments there are also worth noticing for us here.

Moreover, Singapore’s trio of banks – DBS Group Holdings Ltd (SGX: D05), Oversea-Chinese Banking Corp Limited (SGX: O39), and United Overseas Bank Ltd (SGX: U11) – are all affected by movements in interest rates. When interest rates are low, their net interest margin gets squeezed, which makes it harder for them to make money. The three are amongst Singapore’s 10 largest stocks.

Some of the key drivers for low interest rates, according to Williams, are “shifting demographics, slower trend productivity and economic growth, and emerging markets seeking large reserves of safe assets.” Let’s take a closer look at each of the three drivers in the context of what’s happening in the US:

1. Shifting demographics

The fact that the US population is ageing can be seen in the chart below clearly:

Figure 1 - Kai Kiat
Source: US Department of Health and Human Services

With an aging population, the labour force participation rate in the US has also fallen since the late 1990s, as you can observe in the following chart:

Figure 2 - Kai Kiat
Source: St. Louis Federal Reserve

2. Lower productivity growth

The Brookings Institute is a renowned think tank in the US. According to the institute’s data, the US has seen persistent declines in its rate of productivity growth. The introduction of personal computers in the 1970s was the last major innovation which has boosted productivity.

Figure 3 - Kai Kiat
Source: Brookings Institute

It remains to be seen if some of the new emerging technologies – such as artificial intelligence, big data, and robotics – can ramp up productivity in a significant manner. When productivity is low, it also means lower economic growth for the US.

3. Large reserves held by emerging countries

Data from the International Monetary Fund show that emerging economies have drastically increased their level of foreign reserves (some of which are in US dollars) over the past decade:

Figure 4 - Kai Kiat
Source: International Monetary Fund

There are benefits to having large reserves – it helps a country defend its currency during difficult economic conditions.

As international reserves grow, there’s a flood of liquidity, which makes it hard for interest rates to rise. The Federal Reserve sets only short-term benchmark interest rates, but it’s the market that determines long-term rates through the forces of supply and demand.

I have no crystal ball to know for sure if Williams will be right or wrong. But at the very least, it’s worthwhile knowing what are some of the factors that can potentially lead to low interest rates in the future.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Ong Kai Kiat owns shares in DBS Group Holdings.