Remember when you bought bonds for the interest they paid? What a quaint notion.
Interest rates continue to grind lower around the world under the weight of sluggish economic growth, deflation fears and quantitative easing by central banks. The latest milestone comes in Sweden where the Riksbank on Thursday cut its main policy rate by 10 basis points, to -0.1 percent. The Swedes, who are flirting with deflation and are worried about the impact of a strong krona against the euro, join Denmark, the European Central Bank and Switzerland in setting negative rates in a bid to spur consumers and companies to spend rather than save.
So much for the zero lower bound. For years after the financial crisis, central banks fretted about that issue. Most central bankers believed it would be impossible or impractical to cut rates below zero, potentially rendering monetary policy impotent. That’s why the Bank of England and the Federal Reserve Board embarked on massive bond-buying programs, aiming to drive down long-term rates while short-term rates were stuck at zero.
But now even zero isn’t sacrosanct. The Swedes were relatively modest in cutting their repo rate to -0.10 percent, but the central bank vowed to go even lower if necessary. That looks like a safe bet, considering that the ECB last month cut the rate on its deposit facility to -0.20 percent. “The Riksbank will, we feel, have to respond more forcefully in the months ahead if it is not to see exchange-rate appreciation depress inflation rates still further,” says Rob Carnell, chief international economist at ING in London.
The Danes and the Swiss are way out in front (if that’s the best way to describe the countries with the lowest negative rates) at -0.75 percent. The big conversation among Swiss private bankers these days is whether to suck in the impact of negative rates on their business, hoping it will prove temporary, or start charging depositors for the privilege of keeping their money in Zurich or Geneva.
The shift to negative rates has made bonds one of the best-performing asset classes, given that bond prices rise as yields fall, but there is likely some limit to how far the trend can go. It’s one thing for a central bank to set a punitive negative deposit rate to encourage banks to lend rather than leave funds with the central bank; it’s something altogether different for a government to charge investors for the privilege of owning its paper. The German yield curve is already negative out to five years, and ten-year Bunds yield a slim 0.32 percent. Japan’s curve looks similar. Even with the U.S. economy humming nicely and analysts speculating about a Fed rate hike later this year, ten-year U.S. Treasuries yield just 1.97 percent.
For pension funds and others that have traditionally relied on interest income, the big fear is that the future will look like Switzerland. In Bern this week, the federal government sold 122.65 million Swiss francs ($131.8 million) of ten-year bonds at a yield of just 0.011 percent. Yes, that decimal point is in the right place. Someone buying the minimum denomination 1,000-franc bond could expect to receive 11 centimes in interest a year. You’d have to own Sf42,000 ($45,117) of bonds to buy a single-shot espresso at your local Starbucks in Geneva (price: Sf4.60) with your annual interest income. And to think banks once gave away espresso makers as inducements to lure new savers.
As Chris Iggo, chief investment officer for fixed income at AXA Investment Managers in London, wrote in a recent note to clients, “It’s hard to see value in most parts of the fixed-income market as a result of the level of yields and unless one has a very pessimistic view about life.”
How do you go long on pessimism?
Get more on fixed income.
