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By Hitesh Patel - November 2019
Getting paid to borrow and spend money? Essentially, that’s what central banks are offering when they reduce interest rates below 0%. Their intent is to encourage individuals and businesses to spend rather than save money and thus reignite stagnant economies. However, thus far it has not worked as expected.
In my latest video, I explain why European investors are still investing in negative-yielding debt even though they will lose money. I also discuss how instead of investing locally, investors with extra capital are looking abroad for income-yielding investments. Moreover, this global search for yield has investors taking on greater interest rate, credit and liquidity risk with diminishing potential for return.
Learn more about the unintended consequences of negative interest rates.
Negative interest rates. There’s an excess of $15 trillion of negative-yielding debt across the globe. The vast majority of that is confined to Europe and Japan. So, investors there are effectively being penalized for investing locally. From their perspective, they need to enhance yield by looking for yield abroad.
The ECB—the European Central Bank—decided in 2014 to controversially reduce interest rates to negative. Not only to stimulate growth, but to penalize savers to not only keep their money in the banks, but to go out and spend.
However, that objective didn’t quite produce the results that the European Central Bank was looking for. And, in fact, savers began to save even more money as rates became lower. A fear of not only slow growth, but potentially deflation took over investors’ mindsets. So, culturally, European investors have been penalizing themselves by investing in local debt but are looking actively abroad to increase exposure to income-yielding investments.
From an investors’ perspective, they are most concerned about disinflation. This is their real assets losing their value over time. From their perspective, they want to make sure that they preserve capital. When they put money in a bank, they are actually paying a premium to gain access to their capital.
Why would anyone do that? Effectively, they think they are going to lose the value of their assets if they invest them in a risky investment. Within Europe, the fears are not only low growth but negative growth. And the fear is that they will lose purchasing power if they do not invest in a liquid investment within the local bond market.
There’s also another economic disincentive in Europe. And that is that pension investors, private banks and insurance companies—they’re highly regulated. These regulations—such as Basel II, Solvency II—force these investors to keep some of their investment portfolio in highly liquid, low-risk assets. So, they are making decisions to be invested in negative-yielding debt, despite the fact that they will be losing money because of these regulatory requirements.
What is the offset of that? They need to find yield elsewhere. So, for the portion of the portfolio that is not required to be in these low-vol[itility], low-return-generating, or negative-return-generating assets, they need to take on more risk. And they can do that again, by looking for yield elsewhere, taking on (potentially) credit risk or duration risk and even currency risk in the search for yield to offset those regulatory requirements.
The demand for yield has basically pervaded the globe. We’re seeing massive flows in the emerging markets, primarily because yield there is positive. But with each of these potential investments, investors have to consider all of the offsetting risks. However, those need to be factored in, an investment manager who’s extremely experienced can help guide decision making in both these marketplaces.
Get additional insights in our latest Investment Outlook.
Markets may have panicked today, but we think it’s best if investors respond with poise and patience instead.
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Here’s the role the Federal Reserve has played in the 2020 economy, and what policymakers are expecting for the rest of the year.
June 2020
Global Fixed Income Co-CIO John Lovito expects fewer central bank policy fireworks in 2020. Here’s where he’s finding opportunities.
First Quarter 2020
Investors may take on unintended risks in their pursuit of return in a negative interest rate environment. PM Hitesh Patel explains the tradeoffs.
November 2019
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