Rupert Elwes discusses changes in market sentiment over the last quarter

Interest rates continue to fall to record lows. At one point during the quarter, Germany was able to borrow two-year money at zero per cent, such was the demand for safe havens – though it is strange that the country is apparently regarded as risk free.

One way or another, Germany will share the costs of the Eurozone crisis, either through taking on peripheral Europe’s liabilities in order to save the single currency, or by accepting default among those peripheral Eurozone countries to whom it has lent money.

German credit

The shock decision by Moody’s on 24 July to cut Germany’s coveted top credit rating from ‘stable’ to ‘negative’ highlighted analysts’ concerns. If the German currency were somehow to separate from the Euro, the resulting revaluation of the Deutschmark would almost certainly be accompanied by a banking crisis and recession.

In any scenario, therefore, the German state will see an increase in its funding requirement. The conclusion must be that lending money to the country for nothing represents extreme short-term risk aversion rather than a true reflection of Germany’s underlying credit risk.

All the recent headlines have been about record lows in US, German, UK and Japanese bond yields. The figures are so extraordinary that they often distract us from thinking about what is going on in other parts of the world, where the economic cycles that we witness are rather prosaic by comparison.

In Brazil, interest rates have also fallen to an historic low – which, oddly enough, is 8.5 per cent. In recent years, borrowing rates in Brazil have been punitive by western standards, and as a result there exists in the country only a nascent mortgage market and a limited domestic bond market.

While in the US and Europe the availability of credit was excessively easy for far too long, the reverse has been true in places like Brazil. However, as interest rates fall, credit ratings improve and borrowing money becomes easier, the consumer will be liberated and economic growth will be fuelled. This process has only just begun and it could take a generation or more before it runs to the excesses that were recently seen in the UK and America.

Property market

While Brazil will of course continue to be subject to the vagaries of the economic cycle (and it remains vulnerable to a commodity downturn), the long-term picture is favourable because of this generational move downwards in interest rates.

The example of China is also interesting. There have been problems with the residential property market overheating, and Chinese monetary policy was tightened in 2010 and 2011 in order to cool down the market.

Now that property prices have corrected and many of the excesses have been curbed by other measures like home purchase restrictions, the Chinese recently felt able to cut interest rates for the first time since 2008. They now stand at 6.25 per cent. As with the Brazilian example, the rate itself is unremarkable, the short-term direction is downwards and the long-term trends are very favourable. The contrast with the ‘developed’ economies could hardly be greater.

Rupert Elwes is a director and portfolio manager at J O Hambro Investment Management Ltd