Sunday, February 15, 2015

The age of negative interest rates

Nothing captures the consequences of the obsession of world'a major economies with monetary policy fixes to their real economy problems better than this graphic which shows the five year sovereign debt of six countries trading at negative yields.
In other words, investors are paying to hold the debt of these countries. Fundamentally, in a deflationary environment, lenders can make money even with negative interest rates. Further, if market expectations are for further decline in yields, investors can make money by buying even negative yielding bonds as long as their prices keep rising.

The ECB's big bazooka decision to purchase 60 billion euros worth sovereign bonds every month for a prolonged period has jolted central banks outside the eurozone to respond to its potential vulnerabilities. Faced with a weak eurozone and the potential for a break-up of the currency union, speculators have been piling into safer assets of economies like Denmark and Switzerland with the hope of making large profits if those currencies appreciate. Given this and the prevailing deflationary environment, the risks are mainly two-fold - appreciation of currency and accumulation of bad quality assets.

The SNB's decision in mid-January to revoke the euro-franc peg, itself put in place in September 2011 to stem an appreciating currency, was motivated by growing apprehension about the riskiness of rapidly rising stock of eurozone sovereign bonds. The result of revoking the peg was that Swiss franc appreciated over 15% overnight. In order to mitigate the adverse impact on the currency, the SNB simultaneously lowered what it costs lenders to keep money at the central bank from minus 0.25% to minus 0.75%. In contrast, Denmark, which has pegged the krone with euro, appears to believe that the negatives from currency appreciation outweigh the threats from accumulating euro-zone assets. Accordingly, since January the Danish central bank has spent about $24 bn buying euro assets and has lowered rates four times to minus 0.75% on commercial lending.

Sweden and Finland are the latest entrants to the negative interest rate club. The former lowered the benchmark interest rate, the rate at which Swedish commercial banks can take out loans from the Riksbank to minus 0.1%. Last week Finland raised $1.14 bn in a five-year bond auction at minus 0.017%, becoming the first nation in the region to pay negative rates on its debt. Apart from stemming currency appreciation, especially important for countries deeply dependent on exports, negative rates are also aimed at encouraging companies and individuals to invest and spend more and possibly stoke inflation.

It is not just countries that are seeing negative interest rates. Nestle's two year corporate bond, which is due to mature in October 2016, touched the negative territory last week. The eurozone government's austerity programs (and resultant lower deficits) and ECB's sovereign bond-buying program have shrunk the pool of government bonds available for financial institutions (which need safe bonds as collateral for short-term borrowing), forcing them to turn to blue-chip corporate debt. The stock of negative yield sovereign bonds have risen to $3.6 trillion or 16% of global sovereign bonds. See also this and this for more on negative interest rates. 

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