7th March 2016
David Jane, manager of Miton’s multi-asset fund range looks at how negative interest rates are now a natural extension of monetary policy in the hunt for economic growth…
The introduction of negative interest rates in Europe and now Japan doesn’t appear to have had the effect expected by central bankers.
The policy is supposed to stimulate the economy by encouraging individuals and companies to borrow more as it is cheaper and encourage savers to invest in riskier assets rather than leave their money on deposit.
We find the concept of negative yields difficult to understand. Whilst it is possible to believe an individual would be prepared to pay money to deposit his funds in a bank, where they may be safer than in his wallet, for a financial institution to lend money for the certainty of receiving less money back than they lent simply seems too confusing.
While seemingly absurd to those that live in the real world, financial markets have become so divorced from the real world that concepts such as negative interest rates become a natural extension of a monetary policy that has tried ever more novel tactics to increase growth.
So, in practice, negative interest rates are likely to perplex and confuse people and certainly are not likely to stimulate demand.
If borrowers didn’t want to borrow when money was as cheap as at any time in history, they are unlikely to change their minds when it is even cheaper.
Savers may even feel they need to save more as rates get ever lower in order to make up the lost income, rather than take on more risk, as policy-makers hope. Of course, the policy misses the point that the problem is not the price of money, it is an absence of demand in an economy that already has excess debt and worsening demographics.
Central banks are making the assumption that a cut in interest rates from zero to minus one is the same as a cut from five to four. It seems that the relationship breaks down at these low levels and maybe even reverses. Negative rates may have a damaging effect on the economy.
Fixed income investors are now faced with a particularly daunting prospect; they can lend money to governments and be sure of losing some of their money, and potentially more in the event of inflation or default. In the meantime they will experience volatility of their capital. In effect, you put your money in the tin, shake it around for a few years and take what is left back out. A decidedly unattractive prospect.
There are, as ever, positive arguments to support buying bonds on negative yields. There may be positive real yields if inflation is even more negative, or yields may get even more negative, leading to capital gain in the near term; a classic “greater fool” argument.
Alternatively, they can lend money to companies for an ever-dwindling return when those companies seem to have little purpose for extra funds. In the main, companies have made very little capital expenditure in recent years. It seems the main use for additional borrowing in recent years has been for share buybacks, dividends and acquisitions rather than growth capital, at least in the developed world. China is a different story.
We feel it is wise to avoid those areas, particularly in Europe, that are most exposed to this policy, such as bank shares or shorter dated Euro denominated government or corporate bonds, as the risk seems too high.
We prefer to focus on areas where the old rules still apply, seeking out positive returns from attractive assets rather than hoping that there is a “greater fool” to buy loss making assets at an even higher price.