Negative interest rates are not new. The ECB first dropped its rates below zero in 2014, and Denmark’s new rate reduction marks a record low amongst developed economies. There is one benefit to Danes: in August Jyske Bank launched the world’s first negative-interest-rate mortgage at -0.5%, whilst another Danish bank, Nordea, is offering fixed-rate mortgages at 0% for 20 years and 0.5% for 30 years. It is cheaper for the banks to forego interest, or even pay borrowers to take money, than it is to pay the Danish central bank 0.75% to store it.
The idea behind negative interest rates, to stimulate the economy by encouraging banks to lend and consumers to borrow, is not without concerns.
First, the obvious contradiction. The Global Financial Crisis (GFC) illustrated what can happen when the banking system becomes undercapitalised. The European banking system’s flaws were laid bare and regulations were tightened accordingly. Now, however, banks are being pressured to lend money. With poor lending practices a key cause of the GFC, one can see how negative rates could encourage bad banking practices again just to get money out the door. In addition, as rates go ever lower, savers may withdraw their money, further reducing bank funding and limiting economic activity.
Second, investors may be forced to take greater risks in the pursuit of yield. During the GFC, investors often turned to higher-risk asset classes like equities to achieve yield previously found in government debt, and put their capital at greater risk as a consequence.
We are now seeing the effects of this reach into negative rate territory: Greece recently borrowed almost €500 million at a negative interest rate. The debt has to be repaid in just 3 months and the rate is only -0.02%, so the risk to investors is limited. However, Greece only emerged from its bailout last year, and the yield on its 3-month bonds exceeded 23% as recently as 2011, so the Greek government would normally be few investors’ first choice.
There may be an “Emperor’s New Clothes” moment as the world realises the idea of paying someone to borrow money is a potential house of cards. But yields continue to fall, and we acknowledge that we have no clarity on if or when that moment might occur. For now, we are avoiding what we see as excesses within the bond market, understanding the cost to performance in the short term. With equity markets appearing increasingly dependent on central bank intervention, it seems unwise to ‘double up’ by investing in both equities and government debt, which requires faith in central bank policies that we believe may be waning.