Negative yields can go much more negative
The yield on 23 percent of all euro zone sovereign obligations is below zero, according to electronic marketplace Tradeweb. All the negatives are less than 1 percent. The privilege of owning two-month Swiss government paper, however, costs 1.6 percent annually. Investors have often accepted interest rates which are lower than the inflation rate – negative real rates. Nominal negatives are more novel. In fact, economists were so certain no one would pay to hold a security that they referred to a zero lower bound on interest rates. Surely, they reasoned, investors would simply hold cash.
For one thing, though, there just isn’t enough of it. The European Central Bank has issued about 1 trillion euros of notes, while member governments owe 9 trillion. What’s more, the cost of holding cash, in terms of storage and such, is about 1 percent a year, Barclays reckons. So economically speaking, there’s no immediate reason to stop buying paper with negative yields. And the standard theory of monetary policy says the minus signs are needed. Low interest rates are supposed to encourage lending, borrowing and spending. For the interest rate to be sufficiently stimulating, it has to be substantially below the inflation rate.
The euro zone consumer price index is falling at 0.6 percent annually, so the ECB should push interest rates well below that. A rate as low as minus 3 percent could be justified. The ECB isn’t close to that, probably held back by lingering respect for the zero-floor concept and the fear of popular resentment. The reluctance could diminish as negative rates become more familiar, although rates below the cash-substitution rate might require such drastic measures as replacing notes and coins with debit cards that have automatically depreciating balances. The theory is fragile, however. Deeply negative rates could frighten more than they stimulate. Central bankers might have to find other tools. For now, though, slightly negative rates are just part of the new abnormal.
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Frequently Asked Questions about this Article…
Negative yields occur when investors receive less money back than they originally invested in bonds. This happens when the interest rates on bonds are below zero, meaning investors are essentially paying to hold these securities.
Investors might accept negative yields because holding cash can be costly due to storage and security expenses. Additionally, there may not be enough cash available to meet demand, making negative-yielding bonds a more viable option.
Negative yields are quite prevalent in the euro zone, with 23 percent of all euro zone sovereign obligations having yields below zero, according to Tradeweb.
Negative yields are part of a monetary policy strategy to encourage lending, borrowing, and spending by keeping interest rates significantly below the inflation rate. This is intended to stimulate economic activity.
Yes, theoretically, interest rates could go more negative. Economists suggest that rates as low as minus 3 percent could be justified to stimulate the economy, although this is not currently the case.
Deeply negative rates could potentially frighten investors more than they stimulate economic activity. This could lead central bankers to explore alternative tools to manage the economy.
There is reluctance due to respect for the zero lower bound concept and fear of popular resentment. Additionally, deeply negative rates might require drastic measures like replacing cash with depreciating debit cards.
For now, slightly negative yields are part of the 'new abnormal' in the bond market. As they become more familiar, the reluctance to accept them may diminish, although the situation is still evolving.
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