Negative interest rates are in use in Europe and Japan, but should the US or UK adopt them? Rebecca Cretney explains the economic ‘gift’ promoted by Trump and why their adoption is not a foregone conclusion.
A low rate policy makes sense. When you want an economy to grow, you make it very cheap for companies to borrow so they can invest in their businesses. Many countries also need very low rates so they don’t fall over given the ballooning amount of debt around the world, as they do “whatever it takes” to protect their economies.
Trump is pushing Powell because negative yields would not only reduce the cost of borrowing and stimulate spending, they would put downward pressure on the US Dollar. A cheaper dollar makes imports more expensive, so people would be more inclined to purchase US manufactured goods, both in the US (as foreign imports become more expensive) and abroad, as US products become cheaper everywhere. The stock market also benefits, as it would be cheaper for foreign investors to buy US stocks. This is why Trump is calling the change a “gift”.
There is clearly another side to the coin of negative rates. Reduced savings rates mean groups, such as pensioners, have to up their appetite for risk to search for yield. There could also be a possible spike in inflation, while corporates would need to maintain adequate cash reserves due to their increased costs, as imported components become more expensive.
Trump is correct in stating that other countries are already benefiting from lower yields: the German 10-year Bund (its government bond) is yielding around -0.54%, the French 10-year bond 0.03%, the UK 10-year gilt is marginally higher at 0.23%, and the US 10-year is the highest on this list with a yield of 0.64%. These yields aren’t going to change much anytime soon. Central banks are determined to keep rates at record lows, particularly for shorter duration bonds, through quantitative easing.
There is a serious possibility of yields going even lower, particularly if we see a second wave of COVID-19 given there’s no vaccine on the horizon. It’s just too early to ‘call the bottom’, and say that economic growth and investment prices are likely to start to trend upwards.
But can the market force the hand of the Fed? And what about other central banks, such as the UK and Australia, who have also made similar statements about the road to negative rates?
If only the answer were a simple yes or no. While it is less likely to happen for 10-year bonds, shorter maturities could easily trade below zero. It has happened in the UK, and could in the US given the Fed has lost control of the yield curve in the past.
If only the answer were a simple yes or no. While it is less likely to happen for 10-year bonds, shorter maturities could easily trade below zero. It has happened in the UK, and could in the US given the Fed has lost control of the yield curve in the past.
Although Powell is dismissing the market signals now, the market could prove to be correct. Much depends on how the story continues to unfold, particularly with regard to economic growth, inflation and the value of the US dollar.
To look at whether the US, UK and Australian central banks will move into negative territory for 10-year paper, it’s useful to look back at when banks in Europe switched to negative rates in 2014 and 2015
The Financial Crisis was in the rear-view mirror, but growth wasn’t picking up as expected. A big drop in oil prices meant that disinflation was on the cards, which could end in deflation. Memories of Japan were still fresh in policy makers’ minds – an economy that went from hero to zero and then beyond. Due to deflation, between 1991 and 2001, Japan suffered what many call “a lost decade”. If it is cheaper to invest tomorrow, you will wait until tomorrow. And as tomorrow never comes, a vicious cycle develops.
The Eurozone needed to encourage lending to get the economy moving, but at the time credit had been contracting by 5% per annum. So banks were pushed to lend more as the primary route for company financing. How do you encourage banks to lend? You make it painful for them to hoard money in the central bank’s vaults through negative interest rates. The plan worked. After a couple of years of getting used to the then ‘new normal’, credit finally started growing and did so, until very recently, at around 4% per year. It made sense from a political point of view given the huge levels of national debt in Italy, Greece and Spain.
However, Europe’s panacea isn’t necessarily right for everyone. Negative rates may be a good policy for the European Central Bank (ECB) to follow, but the picture in the US is different. The US has a much bigger corporate bond market, so corporate funding isn’t as much of an issue. So, the Fed focuses on talking about the cons, while keeping a keen eye on inflation, which could be the natural bi-product of negative rates.
Equities tend to rally for a number of reasons. First, because investors are forced into the markets in search of return. Second, the cost of borrowing is reduced for corporates, so their profits increase and they have more funds available to reinvest into their businesses.
Property benefits, as more people are attracted to buy property given the lower cost of borrowing.
Commodity prices tend to increase, because the cost of financing stockpiles, and preventing supply issues, is lower than when interest rates are high.
Bonds (corporate and government) are one of the most common ways of generating a higher level of income than is available through cash. After bonds, you look to property and high yielding equity.
Corporate debt prices have fared significantly better than we expected at the outset of the crisis. In other words, yields have remained low. One of the main reasons for this was the extension of the Fed’s powers to buy corporate debt, where previously this support was only available to the Bank of England and the ECB. The possibility of negative rates adds to this.
We manage portfolios which specifically target returns in the form of income. Although for clients who require an income, yields have fallen – the drop is modest from around 3.9% in 2019 to around 3.5% now. The drop in income yield is primarily because of changes we have made to the income portfolios, reducing higher yielding credit, in particular in emerging markets, which we cut entirely. Instead we favour lower yielding, but safer, investment grade and government bonds. The reason we can maintain such comparatively high yields is because of our diversified income flows and, in particular, our alternative investments.
However, bond yields could go lower if Trump has his way and the US rates go negative. But how far could negative rates go? The floor for negative yields is around -1%. That is because there is a price to pay to hold cash e.g. the cost of renting a safety security box. Any lower than that would see wholesale depositors withdraw all their accounts.
Back to Powell. We have seen before that he is willing to do a U-turn if it’s in the US’s best interest. In 2019, the market priced in at least two rate cuts, and some even expected a third. Powell’s initial response was not to pay heed, but he ended up cutting rates relatively quickly. We may therefore see the Fed becoming equally fleet of foot, particularly if the US Dollar continues to strengthen in value. If the currency appreciates just 5-10%, it would put the EUR/USD pair at parity, see deflation kick in, and so prompt the push for negative rates globally.
We regularly publish articles and insights about trends and events in financial markets. Just submit your email address to receive the updates in your inbox.
Clients of Nedbank Private Wealth can get in touch with their private banker directly to understand how goals-based investing can help, or call +44 (0)1624 645000 to speak to our client services team.
If you would like to find out more about how we can help clients manage their investments, please contact us on the same number as above, or complete a form using the links towards the end of the page.
Investments can go down, as well as up, to the extent that you might get back less than the total you originally invested. Exchange rate changes also impact the value of your investments. Past performance is no guide to future returns. Any individual investment or security mentioned may be included in clients’ portfolios. They are referred to for information only and are not intended as a recommendation, not least as they may not be suitable. You should always seek professional advice before making any investment decisions.
Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services.
She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist.
Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.
Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services.
She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist.
Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.
+44 (0)1624 645813
Nedbank Private Wealth manages mainly multi-asset portfolios, so our communications don’t tend to focus exclusively on one asset class. However, today we propose discussing equities. Why? Because when you consider the news headlines, and then consider equity markets, we appear to be living in a parallel universe.
Read moreThe news feed from the coronavirus is all consuming, and rightly so. A disease that was widely touted, just a couple of months ago, as ‘similar’ to influenza has infected millions and killed hundreds of thousands of people.
Read moreTwo major disasters have crossed paths and it seems that the only good news we read about these days relates to how the coronavirus pandemic is slowing down climate change. Otherwise the press is full of heart-breaking stories of loss, peppered with acts of kindness and a sense of us trying to pull together. No one can tell us with absolute certainty what the future looks like, or when this will end. It can feel like we are staring into the deep unknown.
Read moreOne of the first lessons you are taught when studying anything investment related is the role diversification plays. For my investment exams, I was taught a diversified portfolio consisted of around 20 stocks ‒ a mere nod to today’s view. Instead, your portfolios – if you are a client of Nedbank Private Wealth that is – are invested across thousands of companies.
Read moreAs we witnessed in our latest webinar (click here for the Q&A), investors are struggling to understand everything given the tsunami of news. Markets have begun to claw back losses in some areas, but there may well be more bad news ahead, before we see a sustained trend in positive headlines. So what’s next?
Read more“He allowed himself to be swayed by his conviction that human beings are not born once and for all on the day their mothers give birth to them, but that life obliges them over and over again to give birth to themselves.” ― Gabriel García Márquez, Love in the Time of Cholera
Read moreAs children, most of us were excited to visit a sweet shop – I definitely was. Dazzled by the bright display of shelf upon shelf of glass jars, there were sweets of every possible shape, colour and taste – all covered in sugar. Some coins lay in my hand, but which sweets would I choose?
Read moreToo often we believe clients sit in too much cash. We understand why people do this, but we think that too much can be an issue. How much do you really need?
Read moreWe are one of only a handful of wealth managers who use currency management as part of our investment approach. In this short 45-second video, we explain why.
Read moreInternational Women’s Day was on Sunday 8 March, a day that since 1910 has focused attention on women’s rights. The day – and the invitation to speak on the topic at the Institute of Directors on 6 March – prompted me to think through how much has changed for women in the last 110 years. While there are still challenges ahead, this is pivotal time for women.
Read moreAllie Kirk, private banker, speaks to Rebecca Cretney, one of our investment specialists, about the current market turbulence.
Read moreIf you are interested in becoming a client, please complete the form via the ‘become a client’ button below. Alternatively, if you are already a client, or if you have a question about how we help clients in particular circumstances, please use the ‘contact us’ button.
We will get back to you as soon as we can during office hours, which are Monday to Friday, 8am to 8pm (UK time), except for UK public holidays.
Copyright Nedbank Limited 2023.
Thank you for your interest in Nedbank Private Wealth. Please call us on +44 (0)1624 645000 or complete the requested information and one of our team will get back to you soon. We look forward to speaking with you. Please note: If you are an EU resident, we are unfortunately unable to offer our services to you at present.
* Required fields
This is the Nedbank Private Wealth International website. You can access Nedbank Private Wealth South Africa by clicking on the link or using the toggle in the header.
This website is accessible worldwide. We cannot guarantee that the website or the information contained within it complies with, or is appropriate for use in, all jurisdictions. The purpose of this website is to provide information about Nedbank Private Wealth, our products and services, and how we aim to help our clients. Not all products and services referred to in this website are available in all jurisdictions. The information contained in the website is not intended to, and does not constitute, any offer by us to sell, nor it is intended to be an invitation or solicitation to buy, any product or service, and must not be relied on in connection with any investment or other decision. More information is available in the legal notices section of this website. This message will only be displayed once.
This website uses cookies to improve your experience on our website. We recently updated our privacy policy and our cookies policy to ensure you understand how we protect your personal information. Please note that in order to stop cookies being downloaded, you will need to change your browser settings, which we explain in our cookies policy.
