Saturday, December 2, 2023

ZIRP Is An Anomaly

For the United States (U.S.) federal funds interest rate, the period between 2009 and early 2022 (besides a short period between 2017 and early 2020) was known as the zero-interest rate period, or ZIRP, as a response to and result of one of the biggest financial events known as the Great Recession. Although “zero” was not technically correct, the rates were hovering near the zero line (see Fig. 1), thus I guess that was why it gave the acronym. During this period, debt was cheap, and with it fuelled huge purchases of assets and accelerated growth of capital.

We see this happening here in Singapore, too, especially on the property front. As the U.S. interest rates are positively correlated to Singapore’s (see Fig. 2), our average overnight interest rate (equivalent to the U.S. federal funds rate) was also near zero at around the same time, we had seen a huge demand for local properties simultaneously.

Fig. 1: 25-year United States Fed Funds Interest Rate (source: Trading Economics)


Fig. 2: 25-year Singapore Average Overnight Interest Rate (source: Trading Economics)


For some Millennial (born 1981-1996), Generation Z (born 1997-2012) and late-blooming Generation X (born 1965-1980, like myself) investors, the ZIRP was the time when they had started their investment journeys. Due to the relatively extended period of ZIRP, the sense of it being a given was naturally entrenched in some of their investment philosophies.


However, if one studies the history of markets and economies, we know there are things called cycles, and with this ZIRP could not last long. In fact, ZIRP lasting this long was deemed an anomaly, since rates had not gone that low for the past 50 years. Interest rate has a role to play in the whole scheme of things, and it is the go-to tool to combat an overheated economy and the related phenomenon called inflation. We saw this happening when inflation started to go up hard in early 2022, attributed to major factors like the post-COVID19 supply crunch and the long ZIRP, and the U.S. Federal Reserve came down on it hard with spiking interest rates.




One asset class that was particularly hard hit by rising rates is real estate investment trusts (REITs). If remembered correctly, when rates were going up (known as quantitative tightening back then) in 2017, REITs, being leveraged, displayed a downward trend known as “taper tantrum” emerged, as it was seen the cost of debt would be going up. While rates stabilized sometime in 2019, REITs had gotten used to it and prices went back up to their valued norms.


The rates rise in 2017 could be seen as a precursor of what would happen if they went up again. Still, for 2022, the effects were more pronounced because of the rapid acceleration of rates increase and there was a return to ZIRP at the onset of COVID19. REITs that were highly leveraged were caught out, and with the added effects of risk premium compression, they got battered.


High Interest Rates Are An Anomaly, Too


Viewing from the other side of the coin, a high interest rate would not be sustainable in the long run. Due to the shock of the near-vertical climb, most were literally and figuratively caught with their pants down, as the market and economic models were still at ZIRP mode.


The next obvious question is, how high interest rates are supposed to be? Looking back at Fig. 1, rates were the same, if not higher, pre-2008. In all fairness, going back to that norm 15 years ago would be hard to swallow as of now, and this means “high” is more relative than fixed at a certain percentage.


We must understand that one of the functions of the Federal Reserve is to conduct monetary policy, and raising and lowering rates is a tool used to carry it out. They do not change the interest numbers on a whim, but rather based the decision on the latest economic data and reports presented. In other words, and as what famous fund manager Peter Lynch had mentioned, no one can predict interest rates, not even the Federal Reserve themselves.


Combining what was said in the last two paragraphs, interest rates would be normalized depending on the economic conditions of the time, and the rate percentage would be adjusted in relative to the last one. In summary, though staying at present levels is the norm back in 2007, it is deemed too high as of now. If reversion to the mean is followed, it would go down, eventually, to an average level.


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