What does the future hold for interest rates?

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headquarter of the federal reserve in washington, dc, usa,fed Copyright : Mesut Dogan // 123 RFWith the U.S. Federal Reserve scheduled to announce its latest rate decision on Wednesday, what can institutional investors expect?

Rob Almeida, global investment strategist at MFS Investment Management, says he expects a 25-basis point cut. “I think anything different from that would be a surprise to the market.”

Since the last cut the data has incrementally worsened, but it wouldn’t be a catalyst for a larger move, he notes.

While he doesn’t know if rates will eventually go negative in Canada or the U.S., he says anything is possible. “I think anything can happen because finance isn’t science. It lacks an equivalent theoretical structure. You can’t test negative rates in a laboratory. Financial systems are self-referential.”

Also, the world is currently oversupplied, he adds, noting the internet has created product quality and pricing transparency. “All these things have combined to create abundance of supply and choice for consumers, and I think we have to work all that off . . . and so between now and then I don’t know if rates go to zero in the U.S. or Canada but I think they can stay low for maybe a lot longer than people expect.”

The economy saw quantitative easing in a crisis era and it continued in a non-crisis era, which pushed investors out on the risk continuum, he adds. “And because assets aren’t easily substitutable — ‘You know, my treasuries get taken away from me and it’s forcing me out into a higher risk product.’ — so it forced investors out into bond proxies.”

This signalled to the producers of the world that people will pay a premium for the promise of capital returns, Almeida notes. At the same time, there’s been decreased capital investment and low productivity. And quantitative easing created a dynamic that rewarded companies for substituting labour for capital, he says.

“And so that led to, I think, where we are today where companies have underinvested. They’ve underspent in [research and development], in innovation and now their costs of doing business are going higher. So the risk for pensioners, or for any asset owner, I think, today is owning a company whose margin is way too high because they’ve cut costs. They’ve inflated their buy-back policy through leverage. They’ve done all these sorts of things against a backdrop of really no revenue growth. And ultimately that’s going to make its way through.”

This puts asset owners at risk of owning something that’s structurally impaired, adds Almeida. “I think the opportunity is simply the opposite. If you own an asset or a financial asset of a company that does have public utility, it does have real margin durability and cash-flow strength and all those sorts of things, that I think is going to be a fairly scarce entity and those stocks, or those bonds, will do quite well.”

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