## Low Real Interest Rates Support Asset Prices, But Risks Are Rising

_IMF Blog, January 27, 2022_

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**Canonical URL:** [Low Real Interest Rates Support Asset Prices, But Risks Are Rising](https://www.imf.org/en/blogs/articles/2022/01/27/blogs012822-low-real-interest-rates-support-asset-prices-but-risks-are-rising)

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## Bibliographic details
- Authors: Tobias Adrian, Nassira Abbas
- Published: January 27, 2022

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### Drivers of low real interest rates and asset valuation effects
- Supply disruptions coupled with strong demand for goods, rising wages and higher commodities prices have pushed inflation above central bank targets.
- Many economies have started tightening monetary policy, leading to a sharp increase in nominal interest rates, with long-term bond yields recovering to pre-pandemic levels in some regions such as the United States.
- Investors base decisions on real rates (inflation-adjusted rates); low real interest rates induce investors to take more risks.
- Longer-term real rates remain deeply negative in many regions, supporting elevated prices for riskier assets.
- Very low real interest rates reflect:
  - pessimism about economic growth in coming years;
  - a global savings glut due to aging societies;
  - demand for safe assets amid higher uncertainty exacerbated by the pandemic and recent geopolitical concerns.
- Low long-term real rates are associated with historically elevated price-to-earnings ratios in equity markets because they are used to discount expected future earnings growth and cash flows.
- In credit markets, spreads are still below pre-pandemic levels despite some modest widening recently.

### Differing outlooks between policymakers and markets
- Federal Reserve officials project that their main interest rate will reach 2.5 percent.
- That is more than half a point higher than what 10-year Treasury yields indicate.
- The divergence implies investors may adjust their expectations of Fed tightening upward both further and faster.
- Central banks might tighten more than they currently anticipate because of persistent inflation; for the Fed this could mean the main interest rate at the end of the tightening cycle might exceed 2.5 percent.

### Implications of the rate-path divide for markets
- As a result of high inflation, real rates are historically low despite the recent rebound in nominal interest rates:
  - In the United States, long-term rates are hovering around zero while short-term yields are deeply negative.
  - In Germany and the United Kingdom, real rates remain extremely negative at all maturities.
- Monetary policy tightening should trigger a real interest rate adjustment, leading to a higher discount rate and, all else equal, lower stock prices.
- After an exceptional year supported by solid earnings, the US equity market started 2022 with a steep retreat amid high inflation, uncertainty about growth and weaker earnings prospects.
- A sudden and substantial rise in real rates could cause a significant drop for US stocks, particularly in highly valued sectors such as technology.
- Already this year:
  - the 10-year real yield has increased by nearly half a percentage point;
  - stock volatility soared, with the S&P 500 down more than 9 percent for the year and the Nasdaq Composite measure tumbling 14 percent.

### Impact on economic growth and emerging markets
- Growth-at-risk estimates, which link future economic growth downside risks to macrofinancial conditions, could increase substantially if real rates rise suddenly and broader financial conditions tighten.
- Easy financial conditions helped governments, consumers, and businesses withstand the pandemic; this resilience could reverse as monetary policy tightens to curb inflation, moderating economic expansions.
- Capital flows to emerging markets could be at risk: stock and bond investments in those economies are generally seen as being less safe, and tightening global financial conditions may cause capital outflows, especially for countries with weaker fundamentals.

### Policy recommendations and risks
- With persistent inflation, central banks face a balancing act: monetary policy tightening must be accompanied by some tightening of financial conditions.
- There could be unintended consequences if global financial conditions tighten substantially—a higher and sudden increase in real interest rates could lead potentially to a disruptive price revaluation and an even larger selloff in stocks.
- As financial vulnerabilities remain elevated in several sectors, monetary authorities should provide clear guidance about the future stance of policy to avoid unnecessary volatility and safeguard financial stability.

*Source: Tobias Adrian and Nassira Abbas, January 27, 2022.*

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## Content in this bundle

- **"Low for Long" and Risk-Taking; IMF Departmental Paper No. DP/20/15; November 2020**
  - ["Low for Long" and Risk-Taking; IMF Departmental Paper No. DP/20/15; November 2020 (Markdown version)](/-/media/files/publications/dp/2020/english/lflrtea.pdf.md){rel="alternate" type="text/markdown"}
  - ["Low for Long" and Risk-Taking; IMF Departmental Paper No. DP/20/15; November 2020 (PDF)](/-/media/files/publications/dp/2020/english/lflrtea.pdf){rel="external" type="application/pdf"}

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## References

- [https://www.imf.org/wp-content/uploads/2022/01/GFSR-Blog-Chart-1-V2.jpg](https://www.imf.org/wp-content/uploads/2022/01/GFSR-Blog-Chart-1-V2.jpg)
- [https://www.imf.org/wp-content/uploads/2022/01/GFSR-Blog-Chart-2-V2.jpeg](https://www.imf.org/wp-content/uploads/2022/01/GFSR-Blog-Chart-2-V2.jpeg)
- [https://www.imf.org/wp-content/uploads/2022/01/GFSR-Blog-Chart-3-V2.jpeg](https://www.imf.org/wp-content/uploads/2022/01/GFSR-Blog-Chart-3-V2.jpeg)
- [capital flows to emerging markets could be at risk](https://blogs.imf.org/2022/01/10/emerging-economies-must-prepare-for-fed-policy-tightening/)

_Source: https://www.imf.org/en/blogs/articles/2022/01/27/blogs012822-low-real-interest-rates-support-asset-prices-but-risks-are-rising_