We have mentioned common financial quotes in previous commentaries. Mainly, ‘This time is different’ and ‘History doesn’t repeat itself but it often rhymes.’ The global financial market has been trying to reconcile these two competing ideas as central banks experiment with negative interest rates.
There is even an acronym for it, NIRP, negative interest rate policy. A few years ago, I thought negative rates were similar to an irrational number in mathematics. (From what I remember from high school math, irrational numbers can be used in complex mathematical theories but are absurd in the ‘real’ world). And so it was with negative rates, I can grasp the idea of paying interest on my money I am lending someone else, in theory, but why would anyone do that in the real world.
Today, nearly $7 trillion of bonds in the JP Morgan Global Bond indexes have a negative yield. The yield curve in Japan has negative rates on bonds maturing out to thirteen years. It does appear as though something is different today. However, central banks imposing penalty on savers is not new. Historically, the central bank has penalized savers through inflation. If the government can borrow money at 5% with inflation increasing at 4% the real cost of borrowing is 1% not 5%. What is different today is how obvious the central banks are being. Ben Franklin wrote that inflation was a wonderful tax the government can impose on ‘men’s wealth’. Being able to issue paper money and bonds, Congress could pay, clothe, arm & feed troops today and repay in the future with depreciated paper money.
The reason central banks lower the interest rate is an effort to stimulate growth and inflation. Interest rates are the cost or price of money. The lower interest rates are the more likely people are to borrow money to buy equipment or make a major purchase. This is why central banks for the last eight years have been keeping short-term rates near zero, experimenting with quantitative easing, and now exploring negative rates. There are many opinions on the effectiveness of zero rates, quantitative easing, and likely outcome of negative rates. So, will negative rates provide the global economy a jumpstart? In theory…
Negative interest rates are not in the Federal Reserve’s plan. Just the opposite – the Fed expects U.S. economic conditions to improve at a pace that supports one or two small rate hikes in 2016. Still, the Fed’s expectations for economic growth and interest rates have shifted down in recent months.
In addition, global bonds still offer value. Such as high quality corporate issues and some emerging market exposures. Moreover, the direction of most international monetary policies is strongly toward accommodation, this will provide price support for the intermediate future.
To learn more about negative interest rates, or to speak with a professional, contact our wealth management team today.
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