MMM Newsletter and Website Header 10.2.15

From Charles Schwab & Co., Inc.

One of the first times negative interest rates appeared on the radar for many investors was in 2012, when the Danish National Bank pushed its deposit rate below zero. It seemed like an outlier event at the time, but since then, central banks in the European Union, Sweden, Switzerland and Japan have sold trillions of dollars of debt offering below-zero interest rates.

With investors and banks buying this government debt at a nearly guaranteed loss, it seems like the world is turning upside down. It’s a trend that’s unprecedented, says Kathy Jones, senior vice president and chief fixed income strategist at the Schwab Center for Financial Research.

To understand the current global wave of negative rates — and whether it’s likely that the U.S. would embrace them — it helps to examine both their theoretical appeal and how they’re actually playing out in real life.

The intended upside of negative rates

The trillions of dollars in bonds around the world that offer negative rates are unusual in that, rather than guaranteeing a yield, they guarantee that they will be worth less at maturity than when they’re issued.

And while negative rates may not make sense at first blush, central banks employ this strategy to boost their economies and encourage inflation, Kathy explains. For example, by charging commercial banks to hold excess reserves, central banks give them an incentive to lend — to get those money-losing reserves off their books.

That incentive to lend should, in theory, drive more borrowing, which would lead to spending and investment. Consumers could see lower mortgage and loan rates, spurring home and auto sales. For businesses, lower rates could encourage investments in technology, infrastructure and staff, potentially leading to higher employment.

And what if negative rates were passed on to ordinary savers in the form of below-zero rates on their savings accounts? In theory, that could also boost the economy. “Central banks would like to get consumers to spend. So if rates are in negative territory, you wouldn’t want to put your money into a savings account — and you might go out and spend it,” Kathy says.

Finally, central banks hope that by lowering rates into negative territory, they will devalue their country’s currency and give their exports a boost. The low rates make investors look to move money to where interest rates are higher, selling euros or yen (for instance) and buying dollars.

With these potential benefits, going negative may sound like a legitimate way for a country to rev up its economy and reduce unemployment. But thus far, real-life results haven’t exactly turned out as planned. In fact, Kathy notes, negative rates have led to a series of unintended consequences.

When negative rates don’t deliver positive results

In many countries where they’ve been implemented, negative rates have actually diminished the amount of credit available to individuals and businesses. Negative rates sharply reduce the spread between long and short-term interest rates, making lending less profitable for banks — which have responded by lending less.

Also, negative rates have yet to spur much consumer spending. “The banks haven’t passed on negative rates to their depositors because they’re afraid that people will pull their money out,” Kathy says. Instead, commercial banks in negative-rate countries have opted to increase certain fees they charge customers to cover some of their losses.
Another unexpected outcome: Negative interest rates can be seen as a vote of no-confidence in the broader economy. According to Kathy, Japan’s imposition of negative rates led many investors in the Asia Pacific region to see dark clouds looming — and to flee other currencies in the region. As a result, the yen rose in value, increasing the cost of Japan’s exports and dampening the economic stimulus its central bankers had hoped to achieve.

Could the U.S. go negative?

When Federal Reserve Chair Janet Yellen asked banks to include a negative-interest-rate scenario in their annual stress tests earlier this year, investors took notice. But Kathy believes concerns are premature. When it comes to policy right now, we have to accept that almost anything is possible,” she says. “But I think negative rates are unlikely to happen in the United States.”

Such a move would require overcoming logistical — and possibly legal — hurdles. The Fed might even need the blessing of Congress. Given how controversial going negative would be, they wouldn’t likely get it during an election year.

Also, Fed policymakers are well aware of the dubious record of negative interest rates when it comes to stimulating economic growth. “The lack of a boost provided by negative rates in Japan and the E.U. is another reason the Fed wouldn’t want to go down that path,” Kathy says.

Moreover, the U.S. economy is outperforming most other major economies — and is not facing deflation. The Fed continues to lean toward higher rates, not negative ones, albeit with fewer rate hikes than previously forecasted. And the market seems to agree, for a change. Kathy points to Fed funds futures as a bellwether of U.S. monetary policy, and they currently indicate a belief that the Fed will indeed raise interest rates again later this year.

The trend toward negative rates is still a perplexing one that bears watching, especially if they move further into negative territory and achieve different results, Kathy says. But for now, here in the U.S., she adds, “people shouldn’t be alarmed.”


About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC’s) Monday Morning Minute is crafted to provide decision-maker’s with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to retirement plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or or visit the firm’s website at Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.