Lessons from Europe and Japan
Negative rates are a controversial topic and the jury is very much out as to how effective they are. Recent commentary has been toying with the notion that the Fed could use negative rates, but a flurry of Fed speakers have recently denied that they are actively looking at the policy. In fact there are some sober lessons from Europe and Japan for the Fed to consider. Here are some of those lessons:
- Limitation in hard times: The ECB and BOJ were forced to hold their rates during the COVID-19 panic. By contrast the Fed was able to ease financial conditions and cut rates by around 150bps in March.
- Bond yields stuck: The 10year bond yields for Germany and Japan have been stuck while the US 10 year yields fell to 0.66% from a pretty decent 1.92% at the end of 2019.
- Bank stocks suffer: The European Banks Index in the Stoxx has fallen over 60% since June 2014. This is when the ECB first introduced a negative deposit rate to help turn the eurozone economy around. This has impacted the long term profitability of banks and has caused them to retain focus on buying sovereign debt rather than lending to businesses and households.
Hard to justify
It is going to be hard for the Fed to justify negative rates and is not an attractive prospect. It is understandable why central banks are now calling for fiscal stimulus from Govt’s as central banks have just run out of easy options (like cutting rates) to help the economy.
What benefits when rates are negative
In a low-interest rate (and negative interest rate environment there are some winners. Firstly, Gold benefits as the dollar’s rates advantage of over no-interest gold become a disadvantage. Secondly, real estate with rental incomes stands out as a decent investment in a negative interest rate world. Thirdly, shares yielding high dividends will have more appeal than increasingly marginal rewarding bonds.