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  • We've lived through low interest rates and zero interest rates.

  • But investors are not sure how comfortable they feel about negative interest rates,

  • since the talk is of banks charging people to look after their money.

  • So are negative interest rates going to fade and die, or get deeper and wider?

  • With me to discuss this is Peter Westway, head of investment strategy at the Asset Manager Vanguard.

  • Peter, remind us why do we have negative interest rates at all.

  • Well, the reason we have negative interest rates is that central banks in some countries find it necessary to provide additional policy stimulus.

  • They start by cutting rates lower and lower. Then they hit zero.

  • At that point, they can either start printing money by doing quantitative easing.

  • Or now, they're starting to move rates into negative territories as well.

  • What do central banks want us to do?

  • Central banks affectively are trying to get us to spend more money because by doing that,

  • we increase economic activity in the economy in that pushes up inflation, which is what they want.

  • But is it really the case that people are going to be charged for,

  • these people to hold their money in their banks and investors are going to be charged for the privilege of lending to governments?

  • It's not quite the case. Not many banks are yet charging negative deposit rates.

  • And interestingly, as a result of that, that means that probably the pass through from these interest rates isn't getting through to the borrowing rates.

  • So, the effectiveness of these negative rates in encouraging people to spend more is probably a little bit diluted.

  • Ok, so let's look our first chart which tells us how prevalent negative interest rates are at the moment.

  • This shows that around 30% of the current issues out there for sovereign developed market bonds are in negative territory.

  • Now, that's a slight overestimate of how much governments are actually getting a good deal,

  • because of course some of those bonds were issued while rates were still positive.

  • And they've since moved into negative territory in the secondary market.

  • But even so, any government like Germany's, like Switzerland's going to the market now to raise money,

  • is getting a negative yield, which means in effect , we're paying them for the privilege of us giving the money.

  • Peter, why would investors want to invest in a negative yield?

  • Let's have a look at your second chart here.

  • Yeah, I mean, I think the really important point to remember here is why do you hold bonds in your portfolio in the first place?

  • And you're not holding bonds because they give you fantastic returns.

  • Equities are in your portfolio for that.

  • There's only two reasons. One, they provide you a bit of a dampness stability.

  • But second and most important, they provide diversification relative to equities.

  • So what this chart shows you is that if you take the worst quartile of stock market performance over the last 14 years, from 2001 to 2014.

  • So when equities fell 6%, this tells you how different duration bonds apply during those same periods.

  • And what you see is that typically, bonds would go up to counteract it.

  • So that diversification would still happen in negative interest rate world?

  • Yeah, I don't think, I mean I think a couple of years ago, we were beginning to think that this diversification had run out of road.

  • But what's still happening is that as interest rates are falling and falling, where we're seeing that there's almost no limit to it.

  • But the criticism of negative interest rates is being stepped up.

  • We've had Lowry Fynn of Blackrock saying people are going to have to save for longer. Is that correct?

  • Yeah, I think that basic point is correct. But I think it's mixing up too slightly different issues.

  • I think it's definitely the case that because we're moving into a low interest rate world,

  • investors are going to have to save more to earn the same income in their retirement as they would've done a few years ago.

  • Now that's partly being affected by the low interest rates and the negative interest rates that central banks are implementing at the moment.

  • But let's remember why central banks are doing that.

  • They're doing that in order to try and persuade people to bring consumption forward from the future to the present.

  • That's just a standard thing that policy makers do during a period when the economy is in a big downturn.

  • But even when this downturn is behind us, it's still gonna be the case that returns are going to be lower going forward

  • and people are going to have to save more.

  • So, poor old investors are really the people that are caught in the middle here between a bad long-run outcome and policy maker actions.

  • Just very quickly Peter, finally how long we're gonna have negative interest rates?

  • I think we're gonna probably have them for the next year or two.

  • Peter Westway, thank you very much indeed.

  • Thank you.

We've lived through low interest rates and zero interest rates.

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A2 FinancialTimes negative negative interest interest central chart

How negative rates work | FT Markets

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    Kristi Yang posted on 2016/04/13
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