Global economic growth will be flat this year and likely next, at 3.2 percent, as the emerging world slows and the U.S. economy outpaces the rest of the developed world. Despite the relative strength of the U.S. economy, the Fed will keep interest rates low for longer than most pundits expect. To be sure, the U.S. is the growth leader in the G7 and China’s economy is slowing this year to about a 7 percent pace, but the Fed has said that an interest rate increase is out for April, and most analysts agree that September is more likely than June for the first hike in 8 years. The fed funds rate, the overnight lending rate between banks, has been in this 0-to-¼ percent target range since December 2008.
The U.S. job market has perked up considerably in recent months, as nonfarm payrolls have posted better-than-expected gains since November and the jobless rate has fallen to 5.5 percent, largely deemed to be close to full-employment and well below the level in Canada and Europe. Moreover, the rate is below the level posted when the Fed last began to hike interest rates in June 2004.
But the Fed remains concerned about the consumer and the negative impact of the surge in the U.S. dollar on net exports. The Fed’s efforts to flood the financial markets with cheap credit seemed to have done its job by 2014. Gross domestic product (GDP) shot up by 5 percent in the third quarter and by 2.2 percent in the fourth.
More recently, however, a major component of the economy—consumer spending–is showing signs of anemia. Retail sales and mortgage applications declined in the past three months, a troubling signal.
The U.S. dollar has surged with the out-performance of the economy and the move by other central banks to cut rates. Interest rates in the U.S., as low as they are, are above rates elsewhere. As a result, foreign inflows of capital have increased. Another thing that make the U.S. bond market attractive is it’s the deepest, most liquid markets in the world. Currently, the U.S. ten-year Treasury bond yield is just shy of 2.0 percent, while the Canadian yield is 1.3 percent, the German Bund yield is 0.18 percent, the U.K. Gilt yield is 1.5 percent and the yield in Japan is a mere .32 percent. No wonder the U.S. dollar is surging.
This, however, makes U.S. exports more expensive and, therefore, less competitive. This hurts manufacturing, another concern for the Fed. The strong U.S. dollar also raises the price of commodities, such as oil, for countries whose currencies have weakened. This reduces demand for oil outside the U.S., which has contributed to the further decline in oil prices in recent weeks.
Another reason the Fed feels no urgency in raising rates is because wages have been stagnant despite the significant improvement in the jobs market. As well, headline inflation (including food and energy prices) has been falling since October. Even core inflation is extremely low. So don’t expect a significant rise in interest rates any time soon.
While low interest rates are good for borrowers, they are very tough for investors. Millennials benefit from low mortgage rates, but Boomers saving for retirement are forced out of less risky fixed income markets into more risky stock markets.
Yields on bank CDs, deposits and money market mutual funds are practically zero. The average money fund yield is 0.02 percent and it could be years before the Fed returns short-term interest rates to more normal levels and the Bank of Canada has cut rates recently and could do so again. Despite a six-year bull market, stocks still look more attractive than bonds or cash, and the U.S. stock market meaningfully outpaced the TSX in 2013 and 2014, especially when taking the plunge in the Canadian dollar into account. But bull markets don’t go on forever.
Boomers are risking their hard-earned savings by betting on a continued run in stocks. Having experienced the market rout of 2008, we know that nothing goes up forever. Someone has said that bull markets are like sex; they feel the best just before they are over. With so much risk, no wonder Boomers are cautious. Nervousness about financial security in retirement is rampant and for good reason.
By far the majority of Boomers, unlike their parents, cannot rely on old fashioned pension plans that guaranteed retirement income for life. Not only have defined-benefit pension plans all but disappeared for everyone other than public sector workers—and
those have been cut back sharply—but Boomers are the first generation likely to spend 20-years or more in retirement.
The growth of defined-contribution pension plans (RRSPs)f since the 1980s puts the burden of retirement savings and money management on the shoulders of individuals who are little equipped for the task. Boomers are forced not only to take full responsibility for saving for their extended retirement years, they have taken on more risk because safer investment returns are expected to be so low.
The best bet for Boomers already in retirement is to keep a large stash of cash on hand—that means at least half a year’s income, just in case. If stocks fall sharply, you don’t want to be forced to sell at markedly depressed prices. If a stock market correction occurs early in retirement, your nest egg will never recover. Boomers need bonds as well, even though rates are extremely low, because if the economy does falter, Japanese-style yields could well emerge and bond prices rise when interest rates fall. Stocks, while volatile, remain a key component of retirement savings because they likely provide the highest returns over the long term. But asset allocation is still the key to sustainable returns.