Negative Rates Wreak Havoc

June 30th, 2016 by

As if the fact that several of the world’s major central banks—for instance, the Bank of Japan (BOJ) and the European Central Bank (ECB)—have dropped their benchmark interest rates below zero wasn’t already bad enough, it’s now clear that this contagion is spreading.

Negative Yields All Around

negative interest rates (NIRP)For the first time ever, the 10-year German Bund yield is in negative territory. Bunds are considered among the “safest” forms of government debt in the world due to the strength of the German economy and the country’s reputation for fiscal conservatism.

Similarly, Swiss bonds are offering negative yields even further out than this 10-year horizon. Switzerland is likewise noted for its conservative fiscal philosophy, which is why many investors trust its government debt. In Japan, sovereign debt carries a negative yield out 17 years according to rating service Fitch.

Both of these developments are no doubt a direct consequence of subzero interest rates. To some extent, they also signal that inflation expectations are generally running near zero or below (i.e. deflation).

debtOver the course of the past month, an additional $1.3 trillion worth of government bonds have seen their yields drop into negative territory. This brings the total value of global sovereign debt offering yields below zero to a staggering $11.7 trillion.

According to the Financial Times, “Frenzied demand for high-rated government debt in the wake of Great Britain’s vote to part ways with the EU have sent sent yields a swath of haven bonds plumbing new lows.” In layman’s terms, the premier economic-focused publication explains that “if investors hold the [negative-yield] bonds to maturity they will get back less they put in.”

Given these conditions, even the Federal Reserve is now highly unlikely to continue its path towards normalizing (raising) interest rates anytime soon. The betting markets place a 75% chance (3-to-1 odds) that the Fed won’t raise rates in the next 12 months, and even give a non-negligible chance that it actually reverses direction and cuts rates.

Widespread Impact

One consequence of this artificially low interest-rate environment around the world has been the appearance of pernicious asset bubbles in the financial markets, particularly in equities. Even as economic growth stagnates and companies struggle to squeeze out profits, stock prices and corporate valuations continue to rise. The potential upside of these shares is undoubtedly limited. Moreover, at some point these bubbles are bound to pop, leaving investors with a huge hit to their bottom line.

man sitting on gold barsPortfolio manager Chad Morganlander succinctly put it this way: trying to find the winners by buying stocks right now is “like picking up dimes in front of a freight train.” Said differently, picking stocks is a very risky endeavor right now.

These are the periods of economic turmoil that absolutely call for an allocation of gold in one’s portfolio. This means physical gold; although many investors prefer the convenience of exchange-traded products supposedly backed by gold, these shares are little more than paper if the markets fall dramatically. When it comes to effective safe-haven assets, if you don’t hold it, you don’t really own it.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.