Since the start of the year 10-year index-linked gilt yields have fallen from minus 0.1 to minus 0.4 per cent - a fall which mirrors the decline in US index-linked yields. This reflects the fact that investors expect real yields to stay low. They are pricing in five-year real yields of just 0.3 per cent in five years’ time, which implies that they expect nugatory real interest rates even a full decade after the financial crisis.
This fall in rates is odd for two reasons. One is that western stock markets haven't moved much this year, so the drop in yields cannot easily be attributed to a rise in risk aversion and consequent increased demand for safer assets. The other is that China’s economy will rebalance from export-led to consumer-led growth in coming years, and this should help to reduce the savings glut that has held down yields.
This poses the question: why, then, have yields fallen? One possibility is that investors - in the US as well as UK - are increasingly sympathising with Larry Summers’ theory that we are in an era of secular stagnation, "a situation where natural and equilibrium interest rates have fallen significantly below zero." The idea here is that a slower rate of (monetisable) technical progress, among other things, has caused a dearth of investment opportunities. This means long-run economic growth will be weak - requiring consistently loose monetary policy to support the economy - and companies will have little demand to borrow. The upshot will be low interest rates.
The evidence for this view is clear. In both the US and UK, companies have for years been investing less than they’ve retained in profits - something which the OBR expects to remain the case in the UK. Reflecting this, the share of business investment in GDP has trended downwards for years and companies have repaid debt and built up cash balances, despite low interest rates and, recently, an increased availability of credit.
Equally, though, you might think there's clear evidence against this. A survey by the CBI last week found that manufacturers’ investment intentions are at their highest level since 1997.
However, this in itself is not inconsistent with secular stagnation theory. Secular stagnation is a story about long-term trend growth. Long-term stagnation is entirely compatible with cyclical upturns but these - stagnationists say - will be bubbles that end in bursts.
And previous rises in capital spending have indeed often been bubbly. Two US economists, Salman Arif and Charles Lee, have shown that around the world periods of high investment lead to falling share prices, earnings disappointments and slower economic growth. This is consistent with investment being driven not by genuinely profitable opportunities but by over-exuberant animal spirits.
If this is right, then real interest rates could stay low even if capital spending does pick up - because long-term investors will fear that the increase is only temporary and will end in a bust. It is only if long-term real growth prospects genuinely improve that fears of secular stagnation will fade and real interest rates will rise markedly. And for now, investors are reluctant to bet on this.
