Our central scenario is that in a low growth environment with negligible inflation, interest rates will remain very low over a prolonged period. It is quite possible that the European Central Bank will leave its rates unchanged at least until 2018, if inflation in the Eurozone remains below 2%.
We have long lived with the belief that interest rates defined the time value and included the cost of risk. In this sense, the recent appearance of negative rates on deposits or on sovereign debt creates an unprecedented situation where borrowers earn money from lenders. This is a complete revolution whose impacts we have not finished measuring.
This long period of very low rates affects banks, as a significant part of their profitability (though variable from one institution to the other) is determined by the interest rate spread between their resources (deposits) and the use of these funds (loans). Banks are also penalised when they seek to place cash on their balance sheet on deposit at zero or negative interest rates.
The fall in interest rates also impacts insurance companies - it reduces the yield on new investments while increasing the present value of their liabilities. This weighs both on their profitability and on their solvency levels.
Finally, this context is completely changing the world of wealth management. Borrowers are the main beneficiaries of lower financing costs. For investors on the other hand, the situation is more complex. Income on cash savings has almost completely disappeared and is also vulnerable to monetary erosion via the gradual rise in inflation. There are ways – at least in theory – to generate positive returns. One could invest in equities (where the return from dividends is currently higher than most bond yields) or lengthen the average maturity of fixed income investments or buy “credit”, (i.e., bonds issued by corporates and sovereigns with lower ratings). But by doing so, there is a real danger of taking on more risk than is desirable or perhaps necessary.
Our management and investment advisory teams are at your disposal to help you adjust this risk and to offer a sound and tailor-made management of your assets and liabilities that is consistent with your investor profile, with the indispensable long-term vision that this unstable and radically new environment requires.
We trust you will find this new letter makes interesting reading.
Jeanne DuvouxHead of Private Banking, Managing DirectorSociete Generale Bank & Trust