Upside-Down Lending: A Look at Negative Interest Rates
Below-zero interest rates overseas are pushing U.S. investors to look harder for yield
Though more than two years have passed since the European Central Bank (ECB) first lowered a key interest rate below zero, the very idea of negative interest rates—paying people to borrow money—still seems upside-down. “What we’re seeing in the bond market is bizarre and unprecedented,” says John Boston, Director of Fixed Income for Regions Investment Management in Birmingham, Alabama.
Have negative interest rates worked?
The ECB’s unusual decision in 2014 was intended to jump-start sputtering eurozone economies by enticing businesses and individuals to borrow and spend. Since then, countries including Sweden, Switzerland, Denmark and Japan have followed suit.
While those economies continue to struggle, negative interest rates may have helped prevent a bad situation from getting worse, says Dan Sichel, a professor of economics at Wellesley College and former economist with the Federal Reserve Bank. “Borrowing costs for people and businesses have come down, as central bankers hoped would happen, and borrowing has become stronger.”
At the same time, negative rates have made it harder for investors to earn income from bonds. That’s true even in the United States, where the economy is growing and the Federal Reserve has not and is unlikely to introduce negative rates, Boston says. In search of yield, he adds, “Europeans and other foreign investors are leaving their home markets and piling into U.S. markets.” That surge has depressed U.S. government and corporate bond rates.
How should U.S. investors respond?
As low rates continue, investors may want to consider adding stocks (or investments other than just bonds, based on risk tolerance) to their portfolios, even in retirement, Boston suggests. While all investments carry risks and returns and are not guaranteed, equities may offer the best protection against inflation, he says. As for your fixed income portfolio, Boston suggests considering bond ladders—series of bonds that mature at a staggered pace. And he recommends shorter-term bonds—10 years at the longest—so you’ll be ready to take advantage when interest rates rise. Your advisor can help you determine a mix of investments that’s appropriate for your situation.
Finally, Boston emphasizes the need to stay tuned to what’s going on overseas. “You have to take into account what the other central banks are doing abroad,” he says. “We are all globally interconnected now.”
