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    It's the negative real interest rates at work! So, when will this frenzy end?

    Synopsis

    The real economy will continue to sputter and suffer but the tail (financial economy) will continue to wag the dog (real economy).

    By Ajay Bodke

    Usually, financial assets like equities and bonds tend to outperform physical assets like real estate and precious metals whenever inflationary expectations are well-anchored and the medium-term inflationary outlook is benign.

    On the other hand, in an environment of high inflationary outlook, investors prefer physical assets, as they tend to withstand the ravages of erosion in buying power better. Gold also acts as a store of value in high inflationary environment. All these usual correlations between asset classes are getting mixed-up currently.

    One of the key reasons for this can be attributed to the prevalence of negative real interest rates in a broad swathe of economies. Whereas the world was previously used to negative real interest rates in Japan for decades; lately in many other large economies in the European Union, Switzerland and even the mighty United States have veered towards negative real interest rates.

    Negative real interest rates are fuelling the sharp rally in risk assets like equities from the recent lows we saw in March 2020.

    Fears of reluctance by politicians to unwind massive fiscal stimulus programs and similar pressure on central banks to continue their ever-rising bond-buying programs to stimulate economic growth are leading to concerns of debasement of paper currencies and sharp rally in precious metal prices like gold and silver.

    Usually negative real rates spur huge capital expenditures by businesses, but with weak aggregate demand due to job losses, pay cuts, health concerns etc; the private sector is unwilling to invest.

    Stretched balance sheets with loss of revenues and rise in welfare expenses is making it tough for governments to pump-prime economies. Geopolitical tensions have impacted trade flows and export demand. This has resulted in asset price bubbles, which will keep on getting bigger and bigger.

    The real economy will continue to sputter and suffer but the tail (financial economy) will continue to wag the dog (real economy).

    So, what could potentially spoil the party and end this risk asset rally? When investors realise that central bank balance sheets have been so perversely bloated and governments have so grossly abused fiscal boosters that debt-to-GDP ratios have become unsustainable. Till that time, equity markets will continue to party.

    (Ajay Bodke is CEO & Chief Portfolio Manager (PMS) at Prabhudas Lilladher. Views are his own)
    (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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    2 Comments on this Story

    Guest Login48 days ago
    Hide in gold... first central banks can’t stock printing at first place and governments and politicians will get addicted to lose fiscal policy . This is not creating demand and increasing investment in productive assets . Once they decide to halt also we will see the mirror that economy is not out of woods and business and demand is big challenge . We are in for long period of ultra low and negative real interest rate ... gold will outshine
    Venkatesha Gupta49 days ago
    In the process the depositors of Banks have bear the brunt. The middle class like retired employees who depended on interest income are silently suffering in the absence of any social security benefits unlike in rich countries.It is time to stop thinking that low interest rates alone solve the problems of the economy.
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