HAMISH MCRAE: Back to normal interest rates – and with a bang

We’re back to normal interest rates, and with a bang. All this fuss about the new normal being different from the old normal – that rates would be permanently lower – is wrong. The surprise is the speed with which it happened.

Look at mortgage rates in the spring of 2007, before the collapse of Northern Rock that fall gave an early warning of the banking crash that was imminent. The average cost of a two-year mortgage with a loan-to-value ratio of 75 percent was just over 6 percent, according to the Building Societies’ Association.

That’s pretty much where it is now, if you can get one. And the yield on 10-year gilts was around 4.5 percent, not far from Friday’s 4.25 percent. What is different is the Bank of England’s base rate, which stood at 5.25 percent at the end of March 2007 and is now 2.25 percent. But according to market forecasts, it will rise to more than 5 percent next year, a relief for savers with extra cash. In the jargon of the markets, the Bank is lagging behind.

The markets have done the job of tightening monetary policy, which the Bank has not done. The markets have traded with characteristic brutality. There is a general rule in finance that things always take longer than you would expect, but when the markets move, they move much faster. That’s exactly what happened.

However, these sudden moves are usually in stocks, not bonds. That led to the Bank’s rescue of the gold market on September 28. As Deputy Governor Sir Jon Cunliffe told MPs, the rise in long-term gilt interest over a four-day period was twice as great as any other previous experience since 2000. The trigger was the loss of confidence in the government after the mini-budget of Kwasi Kwarteng, and I fear that there will be a risk premium for a while.

Among the many victims are the pension funds that were large holders of gilts. When the dust settles, there will have to be a total rethink of how these funds are regulated. In particular, we need to look at the absurd requirements for them to have large positions in low-yield fixed-income securities at a time of high inflation, and the ways in which they used complex – but ultimately catastrophic – financial instruments to try to increase that return.

An important question at the moment is whether gold yields have increased sufficiently. Here I think the common sense answer is: pretty much yes. After all, if the world’s central banks can bring inflation down to nearly 2 percent, as they are required to do, then a return of 4.25 percent for 10 years isn’t bad. That does presume that the central banks will succeed, but there is such enormous political pressure on them to bring down inflation that they are likely to do so. Maybe the yields will increase a little more, but the important thing is that they are at least back to their historically normal range.

If that’s true, there are fairly positive implications for other asset prices, particularly for the UK. The UK is a bargain basement area – one of the reasons savvy investors are pumping money into the country, as we discuss on these pages. I would also argue that in addition to being cheap, there are huge opportunities that have obscured all this political turmoil.

Meanwhile, the return to ‘normal’ interest rates raises some tough questions about the value of assets worldwide. For US stocks, for example, the question is whether the bear market has run its course, and if not, how much further will stock prices fall? Here’s a huge one: Will 6 percent mortgages crash the housing market or just cancel the boom?

We can’t know, but my rule of thumb is that the bigger they get, the harder they fall. Values ​​eventually become meaning again, although it can take forever to do this. You see that happening now. Markets that have reached the greatest highs show the greatest declines.

For example, the FTSE100 index, which had barely risen during the boom, has fallen less than 7 percent this year, while the Nasdaq has fallen by almost a third. As for housing prices, fingers crossed, we will manage to end the boom without a crash. But at least one thing is clear. We’re going back to normal interest rates.