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The Impact of Covid-19 on the Future of Interest Rates

No one could have predicted the onset of the novel coronavirus pandemic in late 2019 and early 2020. The virus spread across the planet in a matter of months with no real end in sight. It is safe to assume that investors from around the world need to think about a...

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No one could have predicted the onset of the novel coronavirus pandemic in late 2019 and early 2020. The virus spread across the planet in a matter of months with no real end in sight. It is safe to assume that investors from around the world need to think about a “new normal” going forward. For many, that means figuring how the future of interest rates will look post-COVID-19.
 
In the weeks that followed the arrival of the coronavirus, yields in the United States and Europe dropped to unbelievable lows. The returns on investments were now slim-to-none and recession could be on the horizon. While some fear that these low yields and even lower interest rates could bring widespread financial losses, problems with debt, and much higher inflation rates that will push interest to higher rates than the ones before Covid-19, others stand firm in the belief that interest rates will remain low long after the pandemic has disappeared. They are not guessing, either — there are plenty of good reasons for some experts to feel this way.
 

Looking back so we can look ahead

 
Because the novel coronavirus is exactly that — a new phenomenon — it is impossible to know what is going to happen in the months and years to come. For this reason, financial experts on either side of the debate have made educated theories about the future of interest rates. Truthfully, though, the best bet seems to be to look at past pandemics and the impact they had on the market. It will allow us to make the smartest predictions about our future post-COVID-19. To understand the future of interest rates, we have to look back at pandemics and interest rates over the last 70 years.
Recently, the San Francisco Federal Reserve Bank, economists Òscar Jordà and Sanjay Singh, and former PIMCO senior advisor Alan Taylor looked at 15 pandemics since the 14th century that resulted in the loss of over 100,000 lives. They concluded that, in each instance, the pandemic had a long-lasting impact on interest rates that kept them low for decades. Of course, there are limiting factors worth mentioning: These past pandemics had a significant impact on the labour force, effectively decimating the number of workers in relation to the capital. Covid-19 has mainly impacted older, retired people that only make up a small percentage of the modern workforce in the United States and the United Kingdom. Additionally, the fiscal response to the novel coronavirus is much larger than responses in past decades. Increase in money supply could lead to higher inflation and higher interest rates, not lower.
 

Estimating the long-term impact

 
Even without these two holdups mentioned in the previous section, there are a couple of other reasons to believe that the financial impact of the coronavirus on interest rates is likely to stay negative going forward. For starters, most businesses are expected to want to save their money instead of spending it to make up for the losses they experienced during Covid-19 shutdowns. It has happened in the past, most recently in the wake of the 2008 global financial crash. It seems fair to say that people will plan on saving instead of spending. All this saving will hopefully offset the high deficits that have plagued the world during the coronavirus pandemic. In addition to saving, it is fair to assume that banks in the U.S. and the U.K. will keep their short-term interest rates low. Not to mention, debt-to-GDP ratios will almost definitely go higher after the end of the Covid-19 pandemic. Thankfully, this all sounds a lot more complicated than it actually is. In reality, the United States has actually already done something similar in the past. In the wake of the Second World War, the U.S. government kept a cap on long-term Treasury yields (at 2.5%) that had been there since before the war began. It helped keep borrowing costs low during the following economic boom and subsequent increase in inflation. These new policies helped to keep the U.S.’s debt-to-GDP from doing permanent damage to the economy. Eventually, when inflation skyrocketed past 20% in the early 1950s, the government finally gained the ability to set monetary policy (commonly known as the Treasury-Fed Accord of 1951). Ideally, if North American and European countries follow a similar plan, the long-term financial impact will not be as severe as some of the less constructive alternatives some experts have predicted.
 

The bottom line

 
While this might sound like a lot of confusing economic jargon, the point is a lot less difficult to understand: it might feel like the Covid-19 pandemic is the first and only crisis of its kind in the entire history of the world, but the truth is that it’s just one of many similar situations the planet has already gone through. The novel coronavirus is certainly a unique pandemic, no doubt, but pandemics have come and gone in decades past and the economy has always found a way to thrive. There is no denying that Covid-19 is a crisis. It is not to be taken lightly, whether you live in the United States, the United Kingdom, or somewhere else entirely. From humanitarian issues to healthcare concerns to economic anxieties, the long-term impact of the pandemic will not just fade out. It is going to take some time to get back to “normal.” The good news is that, eventually (and hopefully sooner rather than later), the threat of the virus will go away. Based on the vast amount of evidence from the past decade, the coronavirus’ impact on interest rates will also be around for a while. With this in mind, investors should definitely prepare for an extended period of record low-interest rates for quite some time.
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What is the impact of lockdown on the price of crude oil?

On April 20, 2020, U.S. crude oil futures fell by 300% to an all-time low of -$40.32 a barrel for the first time in history. Two factors contributed to this decline: Firstly, crude oil storage was much too full. Secondly, refineries were running at historically low...

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On April 20, 2020, U.S. crude oil futures fell by 300% to an all-time low of -$40.32 a barrel for the first time in history. Two factors contributed to this decline: Firstly, crude oil storage was much too full. Secondly, refineries were running at historically low levels due to COVID-19 lockdowns. Now, with no relief from the pandemic, where is the oil price heading for the rest of 2020? To answer this, we need to understand what the main drivers of the oil price are: Supply, demand, and market sentiment.

Global Crude Oil Supply Trend

Since the start of the second quarter of 2020, oil production levels have changed significantly. Most OPEC and Non-OPEC nations have agreed to cut production levels — Some oil producers in the U.S. and Canada are forced to reduce production by 3.5 million barrels a day because of these historically low prices, while others have done it to offset the lower demand. For example, in May 2020, OPEC nations produced 24.77 million barrels of oil per day (down by 5.91 million barrels per day over the same period in April 2020).

During the same quarter, countries like India, China, Korea, and the U.S. created strategic storage solutions for up to 200 million barrels in an effort to take advantage of these lower oil prices. Altogether, these measures are sure to create a deficit in supply for the third quarter of 2020.

Global Crude Oil Demand Trend

Due to COVID-19, global oil demand fell by 9.3 million barrels per day. In April 2020 alone, (year-on-year) oil demand lowered by 29 million barrels per day. It is expected that, in Q2 or 2020, oil demand will be lower by 23.1 million barrels per day compared to Q2 2019. If lower demand is not met with cuts in oil production by OPEC, the U.S., and Canada, then the oil price will almost certainly take a hit.

Commodity Cycles and Market Sentiments

Crude oil prices have a short cycle of 6 years and a long cycle of 29 years. Other factors that affect market sentiment can be calculated by understanding the general position of hedgers and speculators in the futures market.

Market sentiment can be calculated from the futures position of hedgers and speculators. In the last week of May 2020, hedgers (i.e. oil producers) had more short positions (1,297,095 contracts) than long positions (725,955 contracts). On the contrary, speculators (i.e. traders) had more long positions (701,234 contracts) than short positions (158,660 contracts). If you combine the position of market participants with the market cycles, one can make a reasonable estimate of oil price movement.

EIA expects Brent crude oil prices will average at $32 a barrel during the second half of 2020 and $48 a barrel on average in 2021. However, this price path reflects an expected global oil consumption to 97.4 million barrels a day during the second half of 2020 along with relatively high compliance to announced OPEC production cuts, both of which are uncertain. The degree to which the U.S. shale industry responds to the current low prices will also affect the oil price path in the coming quarters.

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