In the wake of attacks in Brussels, TV images from Europe once again relay tragedy and horror. We are less easily shocked by such terrorist assaults than we once were, given their periodic occurrence, though never less appalled. Here are some points that are imperative during these tragic times.
Again, we are ratcheting down the outlook for tourism. Related economic activity suffers when it comes to Europe. We saw tourism fall off in Paris and surrounding areas following the Paris attacks. Eventually, we will see another fall-off.
People will change their plans. At the margin, someone will not go to Europe but will do something else instead; conferences and meetings will be scheduled at venues other than Paris, Frankfurt, Brussels, or Amsterdam; and economic transactions will diminish in the Eurozone and the European area.
Likely reductions in economic activity put additional pressure on the fiscal conditions of those governments. Revenue declines; expenditures for security and safety increase; and budgetary impacts worsen. At the same time, the legislatures and governments of the affected countries add to movement restrictions and security impediments that cause a decrease in economic activity. That is the result of incidents in Brussels, San Bernardino, and Paris, among others.
Europe’s banking system is already damaged. We see the banking system respond to negative interest rate policies (NIRP) in the development of the TLTROs (targeted longer-term refinance operations) that will commence in June 2016. TLTROs will extend credit to commercial banks at zero interest rates for four years. The pressures on the banking system in Europe will now worsen as a result of the events in Brussels. We expect to see more use of zero interest rate financing and more support of troubled banking operations undertaken by the central banks.
For an interest rate policy that ranges from -0.40 (lowest policy rate) to 0.00 (upper band of the policy rate), this 40-basis-point range, below zero, is likely to persist for the rest of the entire decade.
For the purposes of asset management planning, financial transactions, debt financing, and investment allocations, it is important to accept that the zero interest rate will be in place in most of Europe for years to come. That takes the current zero interest rate policy (ZIRP) and negative interest rate policy (NIRP) in the Europe and Japan and etches them in concrete for the rest of the decade.
ZIRP and NIRP, implemented across large economic geographies and sizable and mature economies with a forecasted time period of multiple years, together constitute an extraordinary and powerful force. Most investors underestimate the power of NIRP and ZIRP. The investor class does not understand negative interest rates and finds them counterintuitive. NIRP and ZIRP are, after all, new developments in the modern history of economics and finance. NIRP, once unthinkable, is spreading, deepening, and becoming more negative.
Investors need to grapple with the fact that ZIRP and NIRP are becoming a worldwide phenomenon. They need to think about how they manage and allocate assets under these circumstances. All of the classic models, pie charts, and calculations that were based on market behaviors prior to 2009 are out of date, flawed, and now dysfunctional. It is time to throw them out and think about today’s economic landscape differently. The textbooks do not discuss a scenario in which one-fourth of the economic output of the planet is housed in regions where NIRP is a driving part of central bank policy. All those books are out of date. We are writing the new ones now.
Brussels is another chapter in the continuing saga of radicalized change that is attacking major mature economies and societies. It is one indicator among many other similar indicators and will not be the last. We also know that these systemic and broad global changes lead to many other outcomes.
For their cost in human life, the attacks in Brussels are yet another terrible tragedy in a sequence of many. For the worldwide defensive mechanisms in place, Brussels is a call to ratchet defense up to higher standards. Finally, the tragedy in Brussels is an affirmation for financial markets and economics that this long period of NIRP and ZIRP is likely to extend and broaden for many years.