Low r-star as a global issue - Implications for global asset management

The natural rate of interest has been moving lower not just in the US, but around the world. This should be no surprise; however, the reasons for the decline should concern asset managers. The falling r-star has been measured in the new paper "Riders on the Storm" by Taylor and Jorda as prepared for the recent Federal Reserve Bank of Kansas City Economic Policy Symposium “Challenges for Monetary Policy,” Jackson Hole, Wyoming, 2019. More importantly, r-stars around the world is more correlated. No economy has escaped the decline in the natural rate. This correlated decline affect how central bankers should think about monetary policy as well as how global investor should make allocation decisions. 

Measuring the natural rate of interest (r-star) is important because it can serve as a guide for where interest rates should be and whether monetary policy is tight or loose. The current natural rate global average is negative and has been since the Great Recession. This negative average exists even with current positive global growth. Non-growth factors such as demographics have driven the natural rate to such low levels. Not only are the factors that drive r-star falling but they have become more synchronous. 

Output gaps, monetary stances, inflation, growth, and other factors are all more synchronous and with lower dispersion. The great trade growth since the introduction of the WTO has integrated world economies. The factors that drive interest rates in any country are all similar, so any decomposition of rates shows that the world natural rate has an increasing impact on local rates. The US cannot escape from the global r-star connection. Regardless of political talk, US rates are pulled lower based on world dynamics.

The synchronicity of global economies and natural rates has spillover to all global macro investors. US rates will not move out of tandem with global rates. Investors cannot fight world trends. The bond rally, regardless how much rhetoric of a bubble, is not over until we see signs of global r-star moving higher. Given the tight global relationships in growth and other factors, there is less opportunity for global diversification in either stocks or bonds. There is no escaping systemic global risk. Flight to safety will only further correlate rate links so there will be few places to hide during the next downturn.