Negative interest rates seem to be the new trend. The Bank of Japan just cut interest rates to NEGATIVE 0.1% for commercial banks. “This means that commercial banks will essentially be charged to keep money with the BOJ, which will hopefully serve as an additional stimulus for the Japanese economy,” explains Alex Oldman in TheStreet. “Economists wonder whether it will be effective at spurring inflation to the 2% mark, which Japanese economists have been targeting for years.” It is a bold move and a risky one – but not as uncommon as you might think.
Negative interest rates are an economic tool. “Japan is not alone in using negative interest rates to stimulate the economy. The European Central Bank and the Swiss National Bank have adopted negative interest rates to some degree,” says Oldman. “Furthermore, one of the 17 managers of the U.S. Federal Reserve apparently proposed negative interest rates back in September 2015.”
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Could negative interest rates be coming to stateside? Will some companies benefit or lose out because of the change? And what should investors do now?
Understanding Negative Interest Rates
Investors need to understand that when they hear “negative interest rates” the interest rate in question is the central bank rate. It is not the commercial bank rate that businesses or individuals get when they borrow money. Introducing negative interest rates is a way to stimulate the economy, and it is somewhat limited in scope. Also, reducing interest rates weakens the country’s currency. This can encourage more exports, but it is a dangerous trend. Negative interest rates are a sort of signal that the economy is shaky, and volatility is expected.
The ultimate goal of the central bank is to keep inflation low and steady, but growing. Japan’s inflation rate was up just 0.2% year over year – a decrease from the previous month and only 0.1% once you exclude fresh food prices. Pushing the central bank rate into the negative is meant to jumpstart that figure. Japan’s “move came 1 1/2 years after the European Central Bank became the first major central bank to venture below zero. Sweden also has negative rates, Denmark used them to protect its currency’s peg to the euro and Switzerland moved its deposit rate below zero for the first time since the 1970s,” says Bloomberg. “By the end of 2015, about a third of the debt issued by euro zone governments had negative yields. That means investors holding to maturity won’t get all their money back.”
Could Negative Interest Rates Come to the US?
The Federal Reserve said in a recent meeting that it would “assess national and global developments and how its decisions might impact future inflation and employment,” says Michael Kramer, a founding member of Mott Capital Management, LLC. He continued by saying: “This was the Fed’s way, in my opinion, to start the process of walking back the expectation of future rate hikes and the pace. As we get closer to March, we will hear more chatter about the likelihood and the number of rate hikes diminishing. As a result, the bond market will start pricing in lower rates, helping the Fed out along the way. Eventually, the talk will go from how many hikes, to no hikes, to possibly cuts, and, finally, to negative rates.”
It is an interesting viewpoint and one that could very well become a reality. It won’t happen overnight, but if the markets don’t start improving, the Fed will be forced to backtrack its December interest rate increase – and if the markets STILL are stagnant, the Fed would have to venture into negative interest rates to avoid deflation.
“In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good,” writes Bloomberg. “If banks make more customers pay to hold their money, cash may go under the mattress instead.” If this happens and people withdraw their cash, it could effectively bankrupt the system. But, the alternative is almost just as bad. If the banks try to absorb the higher borrowing costs, it will squeeze their profit margins. In turn, banks lend less money and become more strict on offering credit.
What Does This Mean for Investors?
For investors, negative interest rates mean that bonds are no longer an effective portfolio hedge – when the central bank has a negative interest rate, buying bonds could mean that you lose money if you keep them to maturity. And, that leaves equity. “One goal of negative interest rates is to redirect investors’ money from bonds into more theoretically productive assets like property and stocks,” writes the New York Times. “But in at least one sector, finance, the policy has deepened the equities rout. Banks are reluctant to pass the costs of negative rates on to depositors, for fear they will pull their money out of their accounts en masse. Instead, the banks are absorbing the penalties themselves, cutting into profits.”
More investment in stocks may boost some share prices by momentum alone. For some investors, playing these run-ups is a great opportunity. For others, alternative investments may present a better opportunity for investment. There may be more companies that seek private equity and venture capital rather than pay higher interest rates or navigate stricter lending requirements.