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By Jeremy Glaser and Robert Johnson, CFA | 10-29-2014 11:00 AM

Why Interest Rates Could Stay Low for a While

Several factors, including population growth, income inequality, and low inflation, could keep a lid on rates over the next several years, says Morningstar's Bob Johnson.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. With the Federal Reserve ending its quantitative easing program and talk of rate rises potentially in 2015, many investors are worried about the short-term outlook for rates. But what's more of the long-term outlook over the next five, 10, or 15 years. I'm here with Bob Johnson--he is our director of economic analysis--for his take.

Bob, thanks for joining me.

Bob Johnson: Thanks for having me today.

Glaser: Could you talk about some of the factors that you think about when trying to come up with a forecast, or the way that you think about what rates could look like over the long term?

Johnson: I've been talking for a long time about several factors. We've talked about population growth and demographics as the baby boomers move on as being things that could potentially limit rate growth. And I've also talked extensively about corporations perhaps needing less money than they used to, that our fastest-growing corporations are indeed the ones that are actually generating cash not using cash these days.

But today I want to talk a little bit about a paper by Larry Summers that talked about longer term in interest rates, six factors that may keep the real rate of return on bonds at a very low level for some time to come.

Glaser: Let's start with demographics then. Why will they keep rates low?

Johnson: On the demographics side, there is a very close correlation between population and GDP growth. And right now, our population growth had been running as high as 1.7% in the '50s and '60s, and now we are down to 0.7% on the way to a forecasted low of about 0.5%. So, that will tend to limit the growth in GDP. That means you need less working capital. It means businesses will need to invest less in equipment to grow because there won't be that much growth there.

Glaser: How about the demand for debt, though? How is that going to factor in here?

Johnson: I think, right now, from a corporate side, the demand for debt is really kind of diminished. What's happened is that the corporations have really built up strong balance sheets, they've got some great cash flows, and right now businesses are flush with cash. And going forward, the businesses that are growing the fastest are indeed, like the Googles (GOOGL) and so forth, the ones that actually generate cash the faster they grow. And even look at somebody like an Uber, who has no capital investment or limited capital investment in its market cap on that stock. It shows [what is happening] today and how people are investing without needing a lot of capital goods.

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