In his recent memo to clients, Howard Marks, the founder of Oaktree Capital Management, expressed his views on the current interest rate scenario in the United States. Contrary to concerns about rising rates, Marks contends that the prevailing rates are not excessively high, either in absolute terms or when viewed in the context of historical data spanning the last two decades.
Marks, who began his professional journey in 1969, highlighted that the fed funds rate averaged 8.2 percent during that period. Over the subsequent 20 years, it fluctuated between 4 percent and 20 percent. Considering this historical range, Marks emphasized that the current 5.25-5.50 percent range cannot be deemed as high.
The Oaktree Capital Management founder outlined several reasons for his belief that the US Federal Reserve is unlikely to revert to ultra-low rates. Marks suggested that the last period of normal rates was between 1990 and 2000 when the fed funds rate ranged from 3 percent to 8 percent, aligning with the current rates.
Anticipating a potential increase in inflation post-2021, Marks proposed that the Fed might maintain higher interest rates to curb inflation. Rather than consistently adopting a stimulative approach, Marks speculated that the Fed might aim for a neutral rate, recently estimated at 2.5 percent.
According to Marks, the experience of inflation after decades might encourage the Fed to tolerate another round, impacting interest rate decisions. He concluded by stating that, given these factors, the base interest rate is more likely to average 2-4 percent over the next few years, rather than 0-2 percent.
Is Low Interest Rate a Boon or Bane?
Marks delved into the consequences of low interest rates on the economy. While acknowledging that low rates stimulate economic growth, he cautioned against the potential downsides. Rapid economic expansion fueled by low rates could lead to higher inflation, prompting the need for rate hikes, which, in turn, might discourage further economic activity.
Moreover, Marks pointed out that at zero interest rates, there is no opportunity cost. This situation lowers the “relative bar,” making riskier assets with higher returns appear attractive, even if the absolute returns are low. He coined the term “handcuff volunteers” to describe investors compelled to take additional risks due to ultra-low returns on safe assets.
Marks highlighted the cyclical nature of economic conditions influenced by rate cuts. Stimulative cuts initially lead to positive market developments and easy money, reducing prospective returns and increasing risk tolerance. This, according to Marks, results in unwise decisions, investment losses, and a subsequent period of fear, tight money, and economic contraction.
Despite these lessons from economic cycles, Marks lamented that the behavior induced by low rates often goes unnoticed or unheeded. He attributed this to a combination of ignorance of history, the pursuit of profit, the fear of missing out, and cognitive dissonance that leads people to dismiss information inconsistent with their beliefs or interests.
