Bloomberg (September 22, 2019) reports that $14.3 trillion of global debt yields negative interest rates. US 10-year Treasuries currently yield a meager 1.72%. A quarter of government bonds worldwide offer negative interest rates.
What does this mean?
Interest rates have an inverse relationship with bond prices, meaning you pay a larger premium on bonds in a negative interest rate scenario. In this scenario, people purchasing bonds hope to make a profit by selling them to someone else before maturity for a higher price. Otherwise, owning a bond will certainly lead to a negative ROI. This is because the sum of the coupon payments and the return of principal is less than the price paid for the bond. This is unusual to say the least. In Switzerland, the paragon of financial integrity, ALL maturities from 2-year bonds to 30 years offer negative interest rates; same for Germany and the Netherlands. Canada and the US could be heading that way too, if Donald Trump gets his way.
Why is it happening?
There is no consensus on why this is happening, just a number of hypotheses. Let us review them:
- There is worldwide glut of savings because people save (sometimes too much) rather than consuming.
- People are living longer and worry that they will outlive their savings, so they save money now to prepare for a long life. This hypothesis does not quite fit the facts. Interest rates are most negative in rich countries with strong safety nets for seniors (Switzerland, Germany, Denmark, Holland, Austria, Finland, France, Belgium and Sweden).
- People save more because they were scared by the Great Financial Crisis (GFC) that saw the financial system in the United States, Iceland, and the United Kingdom teetering on the brink of default. But again this does not quite fit the facts because rates are most negative in countries like Switzerland that were barely touched by the GFC.
- We are entering a period of “secular stagnation”. At the end of WWII, Alvin Hansen coined this term to describe the new state of the economy. The glut of savings together with few investment opportunities could lead to negative interest rates.
- Technological innovation and worldwide competition are putting downward pressure on the prices for goods and services; including the price of money (interest on loans).
- Income inequality leads to more savings because the rich can save more than the poor.
- Trade wars induce investors to seek safety in government bonds. This pushes up their prices and thus their yields decline.
- Trade wars are accompanied by the rise of the probability of recession. Central banks are urged to lower interest rates that are already very low. It would not take much to tip them into negative territory in the US.
Very low to negative rates appear entrenched in most rich countries. We do not understand this irrational behavior and we do not know how long this will last. Ultimately, investors may decide to protect their wealth by keeping their money under their mattresses or buying gold. For us, we’ll stick to buying dividend-paying stocks.