24 April 2020

Maybe it's time to start reading about negative interest rates

The math is simple:  Deposit $1000 now, leave it untouched, and next year the balance is $998.  Here are excerpts from an article today in Bloomberg:
Unprecedented situations require unprecedented actions. That’s why the U.S. Federal Reserve should fight a rapidly deepening recession by taking interest rates below zero for the first time ever...

Why the fear of negative rates? A decade ago, the answer would have been that it was impossible to go below zero: Banks would simply avoid the charges by withdrawing their reserve deposits and holding the funds in paper currency, which pays zero interest. But economists now recognize that doesn’t happen, because it’s costly to store billions (or trillions) of dollars of paper currency safely. Several European central banks, as well as the Bank of Japan, have successfully taken interest rates below zero.
A Schwab publication addresses why anyone would tolerate negative interest rates:
There are four main reasons that an investor might choose to buy a negative yielding bond:
  1. Safety. Investors seeking safety in a time of disruption might choose to pay for the security of a Treasury bond. U.S. Treasury securities are considered risk-free, and when markets are in turmoil, investors may prefer to lose a small amount in exchange for knowing that the rest of their principal is safe.
  2. Deflation fears. If an investor believes that prices will fall, then the purchasing power of the money saved, even with a negative yield, could rise.
  3. Speculation. Some investors may believe that yields will continue to fall and therefore believe that the price of their negative-yielding bonds will rise, providing capital gains that offset the negative yield.
  4. Regulatory requirements. Institutional investors like banks may be forced into holding Treasury securities by regulation and have to accept the cost of those negative yields to comply with requirements.
We don’t suggest that investors purchase bonds with negative yields. However, investors may end up holding them at some point if the economy continues to weaken or flight-to-safety Treasury buying intensifies. 
And here are other links for those interested:
Who wins and who loses because of negative interest rates? (SwissInfo)
Why the Fed may need to slash interest rates to zero. (CNN)
Should we love or hate negative interest rates? (Washington Post)
Negative interest rates make sense? (Bloomberg)
"There may come a time in the not-too-distant future when investors don’t expect to collect fixed interest payments from sovereign debt obligations, nor do they expect to earn anything from parking their cash in a savings account. That’s no longer a bond market in the traditional sense. If that sounds like something of a “wealth tax,” that’s because it effectively is. The two choices are to invest in risky but potentially lucrative endeavors or to keep that money safe but have it erode slowly through zero or negative interest rates."
Negative mortgages set another milestone (Bloomberg)
"The world’s headlong dash to zero or negative interest rates just passed another milestone: Homebuyers in Denmark effectively are being paid to take out 10-year mortgages."
Negative interest rates are coming (Yahoo)
And in Europe, it was postulated that negative rates would never fly in the consumer sphere in terms of banks paying back depositors less than they put in their savings accounts, but that’s now changing. Banks in Denmark and Switzerland are now charging customers to hold deposits. And on the flip side, and also in Denmark, mortgages with negative rates are available. That’s right, you get a mortgage from the bank, and the bank essentially pays you each month. A three-year adjustable rate mortgage priced at negative .28% there recently.
How negative interest rates work (Investopedia

1 comment:

  1. Negative interest rates already exist. They're called "bank fees". Hahah.


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