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  Low interest rates make life difficult for savers, and economies stayed afloat, but if a crisis occurred today,
retirees, pension plans and central banks. But
because markets fluctuate, we expect rates to rebound. What happens if they don’t?
Low rates impact monetary policy and investor expect- ations. Some countries have even come to know the curi- ous reality of negative interest rates, which we’ll explore next time in Part 2.
Ten-year government bond yields in Canada and the U.S. (see Chart 1) have fallen from around 10% to 2% over 30 years. Their rebound anytime soon is far from certain.
Chart 1: 10-year government bond yields (January 1988 to November 2019)
12 10 8 6 4 2 0
Source: Federal Reserve Board and Bank of Canada
Central banks used low interest rates and quantitative easing to flood capital markets with liquidity during the 2008-2009 global financial crisis. Most financial institutions
   by M a r k Yamada, president of PUR Investing Inc., a software development firm specializing in risk management and defined contribution pension strategies
there’s significantly less room to manoeuvre.
Low interest rates mean pension plans must increase
contributions, reduce benefits and/or take more invest- ment risk to meet retirement payouts. Investors must similarly adjust to meet their goals. Deferring consump- tion is never a happy choice, particularly if rates stay low.
Future rates are a function of:
› expected inflation;
› expected short-term interest rates; and
› a term premium that compensates investors for the
risk of holding long-term assets exposed to interest- rate and inflation volatility.
None of these factors indicates that higher rates are a sure thing. Organization for Economic Co-operation and Development inflation expectations for 2021 are 2.0% for Canada and 2.2% for all OECD countries.
Expected short-term rates
Interest rates will stay low if the demand for low-risk assets exceeds supply. A number of factors are contribut- ing to higher demand. Since the financial crisis, investors have a growing appetite for “safe” U.S. Treasurys, and banks have higher reserve requirements. Aging popula- tions emphasize saving over spending.
Meanwhile, supply has been affected by the Federal Reserve’s three significant long-duration Treasury and mortgage-backed securities purchase programmes between 2008 and 2014, and asset purchases by U.K., European and Japanese central banks.
Investment strategies start with a neutral or “risk-free” rate of return (r*), the hypothetical return achievable without
   ■ Canada ■ U.S.
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Percent %

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