Originally published by Commonwealth Bank of Australia
- The three Ps of growth are in metamorphosis. The first P, population, is waning as fertility rates decline. The second P, participation, is declining as populations’ age. The third P, productivity, is also being weighed down by ageing populations.
- We are in the middle of a seismic shift. The post-war baby boom was the largest in human history. The baby boomers are now retiring. Their influence on interest rates is profound, and understated.
- Fed researchers say demography explains ALL the decline in real interest rates. We think this fits with other work showing the US real neutral rate is near zero and that market pricing for the Fed to only slowly raise rates to 2% is not too aggressive.
- We are not all created equal. There is one differentiator. Immigration is the fountain of youth. Interest rates in high migration nations like the US, Australia and New Zealand, should diverge further from old Europe and Japan.
- The risks are evening up and we see room for Treasuries term premiums to lift and take 10yrs to 3.0%. But the demographic story tells us we shouldn’t be looking for much more on a through-the-cycle view.
We often hear of the impact of demographics. Demographic shifts influence just about everything we touch. We are in the middle of the largest demographic shift ever experienced. The seismic shift will keep a lid on potential growth and real yields. Yields can rise from here, off historic lows. But we are unlikely to see the levels once deemed “normal”, prior to the great financial crisis.
Interest rates experienced during the great inflation period of the 1970s and 80s are the anomaly – generated by the largest surge in population ever recorded. A population surge that boosted growth, put an enormous strain on resources, and caused inflation to spiral to levels no longer allowed.
Expansionary fiscal policy and regulated market structures, compounded by OPEC, no doubt contributed to higher interest rates. But, according to the US Fed, demographics explain ALL of the subsequent decline in real interest rates, and potential growth rates. That may be excessive, but it fits neatly with theories of a new normal that we think will keep interest rates and bond yields low. Notwithstanding some rise in term premiums to come.
The population boom like no other, drove the never before seen spike in interest rates.
In Figure 3, we overlay global population growth with global interest rates back to 3000BC. What stands out is the baby boom, and the impact on interest rates. The peak in population growth is long behind us, so too is the peak in interest rates. We are now in a “new normal”, with lower terminal rates. We are not all created equal, however. Australia is much younger than most. And fertility is not the source of Australia’s youth. Immigration is the fountain of youth. Immigration policy influences the three Ps of potential growth, and suggests growth and interest rates will be higher in countries like the US, Australia and New Zealand.
Early interest rate settings ~3000BC were between 20-40%. Interest rates declined as markets evolved, and averaged a much more civilised 5.5% between 500BC and 1910. Churches and Kings were known to control interest rates, from time to time. By 1950, following two world wars and a great depression, interest rates had fallen to the lowest levels ever scribed. A record low that was smashed 66 years later with the advent of negative interest rates. The ‘great inflation’ period of the 1970s and 80s stands out. The spike in population preceded the spike in rates.
Global population jumped from ~2-to-2.5bn in 1945-50, to ~4.5-to-5bn in 1980-85. In just 35 years we more than doubled our population. The impact of the tsunami of baby boomers was profound. The surge in population induced the highest levels of interest rates in 5000 years. Interest rates peaked in the early-80s. From 1985 to 2020, the subsequent 35 years, it is estimated our population will rise to ~7.7bn. That’s another 2.7bn increase, but off a much higher 1985 base of 5bn. The rate of growth has halved from that experienced in the baby boom.
The decline in population growth has coincided with a 30 year decline in interest rates. Population growth will continue to slow for the next 35 years. From 2020 to 2055, the next 35 years, global population is forecast by the IMF to hit 9.5bn (+1.8bn). Population growth will halve again. Society has changed. Fertility rates have declined since the 1960s. Family sizes have declined (Figure 4). There has been a steady rise in childlessness, higher divorce rates, and later marriage. There has also been a healthy lift in female labour force participation. Reduced population means reduced pressure on resources and rates.
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