What Investors Should Know about Negative Interest Rate Policies
A new acronym has entered the central banking conversation in recent years – NIRP, which stands for Negative Interest Rate Policy. The use of negative interest rates was discussed during the 2008 financial crisis, but was not implemented until June 2014, when the European Central Bank (ECB) introduced the NIRPs. The central banks of Switzerland, Denmark, Sweden, and Japan subsequently added NIRP. Currently, approximately five currencies and twenty-three countries practice some form of an NIRP. Consequently, over $7 trillion of government bonds worldwide offer yields below zero. By comparison, 10-year U.S. Treasury Bonds currently yield about 2.45%. NIRPs notwithstanding, foreign retail banks have thus far been reluctant to charge negative deposit rates to their customers. This makes sense because the earning of interest by a depositor represents the foundation of a bank’s true franchise, and banks are unwilling to risk losing these customers.
As central banks in these countries experiment with negative rates to ignite their countries’ economies, we know that in the short-term an NIRP devalues currency, and short-term yields become negative. Ultimately, the goal of an NIRP is to spur growth and inflation. The idea is that if investors earn nothing to keep their money in cash or cash-like securities, then they will spend it or invest in other assets, thereby bolstering businesses and riskier assets. Countries also employ an NIRP to punish banks that sit on cash instead of making loans. One wonders about the long-term efficiency of such a policy, especially because persistent low interest rates adversely affect banks and insurance companies.
In the United States, our central bank (the Fed) appears to be trying to restore a positive interest rate policy and gradually return to a more normal stance, which puts the U.S. at one end of the spectrum. Since the election of Donald Trump we have seen a rise in U.S. rates-even before Fed action. The ECB and others are pulling in the other direction with NIRPs, while the rest of the world observes and positions itself in the middle. Fed Chair Janet Yellen is often asked about negative rates. She does not seem to have given any serious contemplation to the imminent use of an NIRP, although the Fed is loath to take any options off the table. Our view is that the Fed will do all it can to avoid the use of an NIRP. The consequences of the world’s global reserve currency having its treasury securities traded with negative yields is without precedent and the implications for global trade and economic activity would likely be negative. Already, certain sectors of the economy, as we alluded to earlier, are feeling the squeeze of low rates.
The massive amount of debt and number of countries operating in an NIRP environment is a new occurrence. It is also unclear whether it will actually help bolster growth. Even with Trump’s ostensible push toward economic policies that will spur growth and inflation, it appears that the NIRP is here to stay for a while, which, according to Apexium’s Chief Investment Officer Matt Marcello, “probably means that low interest rates will linger in the United States, regardless of the Fed’s stance.” This is repressive for savers and fixed income investors, but could be a positive for other asset classes. Apexium’s view is that NIRPs will, over an extended period, create stress within the financial markets. Investors need to manage expectations accordingly and reassess their tolerance for risk and volatility.
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