700 Years Of Data Suggests The Reversal In Rates Will Be Rapid

Have we been lulled into a false sense of security about the future path of rates by ZIRP/NIRP policies? Central banks’ misguided efforts to engineer inflation have undoubtedly been woefully feeble, so far. As the Federal Reserve “valiantly” raises short rates, markets ignore its dot plot and yield curves continue to flatten. And thanks to Larry Summers, the term “secular stagnation” has entered the lexicon.  While it sure doesn't feel like it, could rates suddenly take off to the upside?

A guest post on the Bank of England’s staff blog, “Bank Underground”, answers the question with an unequivocal yes. Harvard University’s visiting scholar at the Bank, Paul Schmelzing, normally focuses on 20th century financial history. In his guest post (see here), he analyses real interest rates stretching back a further 600 years to 1311. Schmelzing describes his methodology as follows.

We trace the use of the dominant risk-free asset over time, starting with sovereign rates in the Italian city states in the 14th and 15th centuries, later switching to long-term rates in Spain, followed by the Province of Holland, since 1703 the UK, subsequently Germany, and finally the US.

Schmelzing calculates the 700-year average real rate at 4.78% and the average for the last two hundred years at 2.6%. As he notes “the current environment remains severely depressed”, no kidding. Looking back over seven centuries certainly provides plenty of context for our current situation, where rates have been trending downwards since the early 1980s. According to Schmelzing, we are in the ninth “real rate depression” since 1311 as shown in his chart below. We count more than nine, but let’s not be picky.

Furthermore, he believes that we are still locked into a 500-year downward trend.

Upon closer inspection, it can be shown that trend real rates have been following a downward path for close to five hundred years, on a variety of measures. The development since the 1980s does not constitute a fundamental break with these tendencies.

Now to the useful bit, Schmelzing looks at how these "real rates depressions" ended. The chart below shows the path of real interest rates in each reversal period following the trough.

He calculates that the average reversal has been 315 basis points within 24 months.

Most reversals to “real rate stagnation” periods have been rapid, non-linear, and took place on average after 26 years. Within 24-months after hitting their troughs in the rate depression cycle, rates gained on average 315 basis points, with two reversals showing real rate appreciations of more than 600 basis points within 2 years.

While we’d rather he ignored tainted “maestro”, Schmelzing states that there is “solid historical evidence” to support Greenspan’s view that real rates will rise “reasonably fast” once they turn. In Schmelzing’s opinion, and we would broadly agree, the best analogy in “recent” times for today’s situation is the Long Depression that followed the Panic of 1873.

Most of the eight previous cyclical “real rate depressions” were eventually disrupted by geopolitical events or catastrophes, with several – such as the Black Death, the Thirty Years War, or World War Two – combining both demographic, and geopolitical inflections. Most cyclical real rate depressions equally coincided with inflation outperformances. But for a minority of cycles, economic fundamentals were decisive, and exhibited both excess savings and subdued inflation. The prime example – and likely the closest historical analogy to today’s “secular stagnation” – is represented by the global “Long Depression” of the 1880s and 1890s. Following years of a global railroad investment frenzy, and global overcapacity indicators inflecting in the mid-1860s, the infamous “Panic of 1873” heralded the advent of two decades of low productivity growth, deflationary price dynamics, and a rise in global populism and protectionism.

Low rates in the wake of a financial crisis, lack of productivity growth, rising populism, etc, all strike a chord with our current circumstances, obviously. Going into more detail about the exit from the real rates depression of the 1880s-1890s, Schmelzing emphasises a rebound in productivity, stronger wage inflation and monetary expansion.

What ended the Long Depression? Labor productivity bottomed out in 1892-3, prior to the discovery of gold at the Klondike, and the associated monetary expansion. Wage inflation started outstripping productivity increases as early as 1885, leading the recovery in general inflation. And US equities finally bounced back from their 15-year lows with the Presidential election of William McKinley – a Republican pro-business protectionist – in November 1896. In other words, there is strong evidence suggesting that the last “secular stagnation cycle” started fading relatively autonomously after just over two decades following the key financial shock, not requiring the aid of decisive fiscal or monetary stimulus.

We find his conclusion, that a rapid, non-linear recovery in real rates can occur without any “decisive” events or policy, almost counter-intuitive. It doesn't feel like it's about to happen, but maybe it didn't in the 1890s either. Indeed, maybe the best analogy for rates today is the proverbial beach ball held under water.


Manthong Wed, 11/08/2017 - 03:04 Permalink

  No it won’t;;; Never before in history have the central banks across the globe colluded to rig the financial markets like today….   Colluded…. Rigged…  geez, where have I heard that before   ??????? 

Manthong Five Star Wed, 11/08/2017 - 04:04 Permalink

 ..the “gold standard” v. oil / energy  was crapped out when Nixon needed to print a ton to “finance” a war……..   …what will happen is when the populace(s)  in the largest economies  stop borrowing anything and hoard  everything of real value. money velocity goes to zero as well as economic growth.   … it’s called “loss of faith”  in whatever currency is in use in a place.  …then it’s Weimar time.  Si quieres verlo en el trabajo, ve a Venezuela ... ... al menos Goldman tiene algo del oro de Hugo.   

In reply to by Five Star

fx Paul Kersey Wed, 11/08/2017 - 08:25 Permalink

Indeed. the omnipresence of central banks, who have long crossed the rubicon, changes everything. A prime example of a market historian who draws analogies to past centuries without really understanding the subject matter.One of the most useless articles/studies that I have come across in a long time.

In reply to by Paul Kersey

Wise Gold Manthong Wed, 11/08/2017 - 04:58 Permalink

You are right. But that party is going to end and end soon I think. ZEROHEDGE is dead on here.  I don't get the 700 years of data thing.  That is a bit of a stretch.   History does repeat itself!The problem is that everyone is crying wolf and the markets keep going up.  I have to say that in that respect the traders on Zerohedge who have been following Shepwave are right.  Just their short term signals make a consistent profit.    jjust the best stock market timing analysis I have ever seen. And I TRUST NO ONE.they are giving a free week of FOREX analysis now too.  see their blog.

In reply to by Manthong

Hugh_Jorgan Wise Gold Wed, 11/08/2017 - 10:20 Permalink

"History does repeat itself!"

Not really, this idea is sort of a fallacy. History "rhymes" with itself. Human nature is fairly consistent, and analogues and parallels certainly abound, but never really repeat due to the myriad of people that create the web of cause and effect that is a new era in time.

Today's situation is somewhat unusual in that we have a modern society with truly MASSIVE monetary system that, in any other time in history, WOULD have collapsed fully after 2008. But this system was kept afloat by US Taxpayers and a WHOLE lot of nefarious legislation and bureaucratic corruption between the banks, the congress, and many heads of industry. All of the branches of government, judiciary, and executive branches along with the Media is now a system is CAPTURED/OWNED by the Fed, the IMF, the BIS and a few minor players. All capital markets are artificially propped-up and controlled. I think that most of the charade will go on as long as enough of the right people continue to believe that it's valuable to do so. The soul-less individuals I'm talking about are not like you and I. They are the worst kind of sociopaths; satanic pedophiles, megalomaniacs with suits and ties. They have zero capacity to self examine or place anyone's interests ahead of theirs. It will certainly end but I think we will see a very unique ending and thus history will be valuable for us to refer to in the broadest terms, only.

In reply to by Wise Gold

Debugas Wed, 11/08/2017 - 03:19 Permalink

trying to extract info from 700 year timespan is meaninglessthe society has changed drastically, the economic reality has changed drasticallythe fact we are not on gold standard now is a drastic change from the past

Spungo Wed, 11/08/2017 - 03:57 Permalink

You can't look at interest rates in raw numbers. They need to be relative to something. A change from 19% to 20% is small. A change from 1% to 2% is huge.

RSDallas Wed, 11/08/2017 - 07:05 Permalink

Hokus pokus! The difference today and since roughly the 1930's is the involvement and effects of the Central Bank and more so for today's times, The Global Central Banks cumulative and criminal effects.

Last of the Mi… Wed, 11/08/2017 - 07:10 Permalink

And just exactly how many of those rate reversals were after the Fed printed $10 trillion? We're way past the point of rapid rate reversals and thier effects on an economy. We passed that during the Obama administration, we're into propping up zombie globalist corporations by the thousands now, peaches. 

The Real Tony Wed, 11/08/2017 - 07:57 Permalink

One has only to look to the laziness of todays' millennials that assures interest rates are still in a downtrend. No demand for anything means falling interest rates. As the old die off and more millennials are born there will be more lazy millennials and zero demand and no growth. The birthrate also means interest rates are still in a downtrend. I bought 30 year Government of Canada bonds not long ago betting on the same thing.

Cardinal Fang Wed, 11/08/2017 - 08:21 Permalink

I don't know, but when I look at the reversals on his chart I see a lower frequency, lower amplitude over time.

So what the fuck is he talking about?

The whole shitshow is heading for a flat line just like the fed funds rate chart.

The real question is how long is the 'golden hour' where resuscitation will revive a viable patient?

With all the talk about zombies...

andrewp111 Wed, 11/08/2017 - 08:44 Permalink

The one big factor that could cause rates to shoot up is WAR. If you look at the news involving Saudi Arabia, it is clear that a really big Mideast war is coming. How it plays out is anyone's guess, but it will almost assuredly be the first nuclear war since 1945.