Negative Interest Rates – Searching for Meaning
We have mentioned negative interest rates in the past. Let’s take a look at what it means to you.
Central banks lower interest rates to encourage economic activity. The theory is that low interest rates allow companies to borrow money at lower costs, encouraging them to expand, invest in and grow their business. It also encourages consumers to borrow money for things like new homes, cars, furniture and all the other things for which people borrow money.
It’s the reason the Federal Reserve has lowered rates to practically zero and kept them there for years. It’s also why the Fed has not raised rates; they’re afraid that doing so will reduce the current slow rate of growth even more.
But if low rates are good for the economy, would negative interest rates be even better? Some governments seem to think so.
Negative interest rates in Japan mean that if you buy a Japanese government bond due in 10 years you will lose 0.275% per year. If you buy a 10 year German government bond today your interest rate is negative 0.16%. Why would you lend your money to someone if they guaranteed you that you would get less than the full amount back? Good question. Perhaps the answer is that you have little choice or are even more afraid of the alternative.
Per the Wall Street Journal:
There is now $13 trillion of global negative-yielding debt, according to Bank of America Merrill Lynch. That compares with $11 trillion before the
Brexit vote, and barely none with a negative yield in mid-2014.
In Switzerland, government bonds through the longest maturity, a bond due in nearly half a century, are now yielding below zero. Nearly 80% of Japanese and German government bonds have negative yields, according to Citigroup.
This leaves investors are searching the world for securities that have a positive yield. That includes stocks that pay dividends and bonds like U.S. Treasuries that still have a positive yield: currently 1.4% for ten years. However, the search for yield also leads investors to more risky investments like emerging market debt and junk bonds. The effect is that all of these alternatives are being bid up in price, which has the effect of reducing their yield.
The yield on Lithuania’s 10-year government debt has more than halved this year to around 0.5%, according to Tradeweb. The yield on Taiwan’s 10-year bonds has fallen to about 0.7% from about 1% this year, according to Thomson Reuters.
Elsewhere in the developed world, New Zealand’s 10-year-bond yields have fallen to about 2.3% from 3.6% as investors cast their nets across the globe.
Rashique Rahman, head of emerging markets at Invesco, said his firm has been getting consistent inflows from institutional clients in Western Europe and Asia interested in buying investment-grade emerging-market debt to “mimic the yield they used to get” from their home markets.
Clients don’t care if it is Mexico or Poland or South Korea, he said, “they just want a higher yield.” ….
Ricky Liu, a high-yield-bond portfolio manager at HSBC Global Asset Management, said his firm has clients from Asia who are willing for the first time to invest in portfolios that include the highest-rated junk bonds.
How and where this will end is anybody’s guess. In our view, negative interest rates are an indication that central bankers are wandering into uncharted territory. We’re not convinced that they really know how things will turn out. We remain cautiously optimistic about the U.S. economy and are staying the course, but we are not chasing yield.