Salient to Investors:

William Pesek writes:

Japan has taught us that slashing interest rates to zero and beyond is much easier than returning them to normalcy. In Japan, credit spreads mean little, the underlying assets on which they are based are drugged up on monetary stimulants, bank balance sheets get muddied, it becomes hard to tell where a central bank’s holdings begin and end, and corporate shenanigans are easier to disguise.

Monetary largesse relieves the pressure on politicians to make industries more competitive and innovative, and concentrates capital in non-productive sectors such as construction, telecommunications and power, and it starves others, like startup companies, that could fuel job growth.

Ultra-low rates have exacerbated Japan’s fiscal woes because the costs of adding debt appear negligible – until the day bond traders decide that a debt more than twice the size of the economy is too great for a rapidly aging population.

Politicians, bankers, investors and businesspeople alike get addicted to free money all too easily and clamor for more.

Central banks start embracing assets such as corporate debt, commercial paper, mortgage-backed securities, ETFs, real-estate trusts etc, tend to get stuck: especially so in nations carrying large, and growing, debt burdens.

Simon Grose-Hodge at LGT said central banks simply cannot afford any meaningful increase in interest rates, and Japan’s  experience suggests very low rates will be here for a long time.

China is certain to fall into the stimulus trap.  The yen’s 20 percent drop in the past 6 months has infuriated Beijing as China experiences its longest streak of sub-8 percent growth rates in at least 20 years.

Nouriel Roubini at NYU expects the Fed to end its zero-rates policy in 2 years. Jan Hatzius at Goldman Sachs says rates will start to rise after January 2016.

Selling off the Fed’s portfolio of mortgage-backed securities in an economy as housing-centric as America’s could devastate a sector closely tied to consumer confidence.

Any step by the ECB to withdraw from euro-zone debt markets would panic investors, and anger China which has been stocking up on euro-denominated bonds.

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