Are negative rates helping?


These three charts suggest not.

Desperate times have prompted desperate measures. But is the extreme medicine working? Savers and investors may wish to look away now.

Savers and investors need economies to grow: it’s good for company profits that flow back to investors and it helps keep interest rates stable for savers. This all makes people feel wealthier and a self-perpetuating cycle begins.

Central banks are trying everything to return economies to the steady economic growth enjoyed before the financial crisis. Most have adopted low interest rate policies, some have imposed negative rates.

But is this the answer to the world’s growth problems? These charts tell a story.

Are low and negative interest rates working?

The graph below shows the economic performance of the six countries – Denmark, Sweden, Japan, the eurozone, Switzerland and Hungary – that have so far adopted negative rates. The data runs to the end of 2015 for each. Most have only gone negative on rates in the past year but all have had exceptionally low rates since the financial crisis.

negative rates

Out of the six countries only the Swiss economy is bigger per capita in dollar terms than it was prior to the credit crisis in 2007.

However, even Switzerland’s economy shrunk in dollar terms in the year after it adopted negative rates, in December 2014.

Denmark has had negative rates the longest. Despite an initial boost, its economy was the second worst performer in our list, behind Hungary which only adopted negative rates in March 2016.

The outlook for growth remains bleak: the Organisation for Economic Cooperation and Development (OECD) forecasts the economies of its member countries will grow by 1.8% this year and by 2.1% in 2017, and it keeps cutting these estimates. Interest rates are likely to stay low and potentially go lower. In the UK, money markets don’t expect the bank rate to rise until 2022.

With the obvious effect on savings rates, it would be understandable for savers to look elsewhere.

How have negative rates impacted markets?

It’s not just official bank rates that are low or negative. The effect, together with electronic money printing programmes, has rippled out into bond markets. Bond prices have risen and their yields, which have an inverse relationship with prices, have fallen.

More than a third of the global government bond market – 37% – now has a negative yield and around three quarters yields less than 1%. Making money from bonds or from savings, where rates are affected by bond yields, becomes very difficult.

This helps increase demand for shares as investors go in search of higher returns. But the story is not so simple.

The graph below shows the performance of the MSCI Europe stockmarket index since the European Central Bank cut rates to negative in June 2014. It tells us three things:

  1. Since adopting negative rates the European shares have gone almost nowhere, despite an initial surge;
  2. Cyclical stocks (those that perform best when the economy recovers), such as banks and commodities, which should benefit from low rates and loose monetary policy, have fallen;
  3. Defensive “safer” stocks, such as pharmaceuticals and “consumer staples” (household goods producers), have rallied.


Why has this happened?

  1. Investors are potentially concerned that central banks are running out of tools to generate growth;
  2. Investors might not believe in the rally, but have to buy something, and defensives, with healthy and seemingly stable dividend income, are the safest bet;
  3. Investors don’t see economic growth converting into better earnings for more risky, cyclical areas of the market.

As a result, the cost of safety is rising.

Defensive stocks such as consumer staples trade at prices around 22 times that of their earnings (the price to earnings ratio is a measure of value, with lower numbers pointing to better value).

It is also why so many investors are buying government bonds, pushing 37% of those on offer on to negative yields.

The negative rates of the past two years have done two things:

  1. Support stockmarkets, although without driving them higher, while depressing yields in other assets
  2. Herded investors into few areas of the market, potentially creating bubbles

What next for each type of investment?

The chart below is the seven-year forecast asset returns from the Schroders Economics Team, based on a number of assumptions.

Seven-year return forecasts (2016 – 2023)

Seven year forecasts

Source: Schroders. For illustrative purposes only. Forecasts are not a reliable indicator of future performance and do not take into account the effect of commissions, fees or other charges.

Accurately predicting the future is near impossible but nevertheless, these conclusions about the next few years make for uncomfortable reading:

  • Cash and bonds would lose money over the long-term in our scenario
  • Stockmarkets look better placed, aside from the UK, but carry risk

As monetary policy has eased further around the world, its effectiveness has diminished further, reflected in the performance of equity markets.

It is likely that while growth, inflation and interest rates remain low so too will returns on bonds and cash.

If interest rates stay low and growth remains illusive, investors could be squeezed into fewer and fewer areas of the market and pay ever higher prices.

The above article by David Brett was first published by Schroders on 18th August 2016.