The boom in stock markets over the past 10 years is mainly due to the artificially low interest rate.
On Friday, anyone buying 10-year US government bonds was rewarded with an interest rate of 3.22 percent, almost equal to that of the past seven years, and greater than anything paid in last 5 years.
The increase in the stock market is the product of artificially low interest rates
It is this rate of interest that will also be monitored by investors in the coming days. Because? The reason is obvious: the boom in stock markets over the past 10 years is mainly fueled by artificially low interest rate. When the Fed and ECB kept interest rates zero for years, investors had no choice but to put their money in stocks to earn something. But now that interest rates are rising, there are less risky alternatives to putting your money.
3.22% is a controllable interest rate, but since it is above 3.4% and close to 4%, it will inevitably have a negative impact on equity markets. Why always invest in overvalued stocks when a single US bond yields 3.5% to 4% interest?
Mario Draghi, president of the ECB, said recently that the euro zone's main interest rate will remain low for months. But on the other side of the Atlantic, the rise in the interest rate began some time ago due to the threatening overheating of the US economy. Since December 2015, the short-term interest rate has already been increased 8-fold. The Fed should still introduce an increase in the interest rate this year and several times in 2019.
Why interest on government bonds with longer term they increase ?
Then there is the long-term interest. The latter is determined by the markets, based on the simple game of supply and demand. That interest has risen sharply in recent weeks. The reason? The excellent results achieved by the US economy in recent months imply that full employment last month resulted in the largest wage increase in more than 10 years. The resulting increase in inflation also resulted in an increase in long-term interest rates, including 10-year government bonds.
The next few days will be crucial in this regard. The midterm elections in the United States were proclaimed as a referendum on its policy by President Trump. Two years ago, the polls were completely misleading and indicated that Trump had only a 5-25% chance of winning the election. Nobody really knows today whether a majority supports or rejects this. The consensus is that the Republicans will lose the House of Representatives, but they will keep the Senate. If this assumption is true, US equity markets – rising for 10 years – would likely fall into a downward spiral because Trump would not be more completely free to pursue its business-friendly program (tax cuts, regulatory easing, etc.). ). ..), as has been the case in the last two years. Government bonds can provide more security for investors and the higher the interest rate, the higher the demand for government bonds.
But by Wednesday morning, the United States and the rest of the world will remain in limbo.