Buying Guaranteed Losses

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Surely one of the strangest trends on the world investment markets these days is banks paying negative rates to depositors, and bonds issued with negative interest rates.  Basically that means that these institutions, and issuers, are guaranteeing a loss when you invest in their bonds or otherwise lend them money.

This unusual trend, which has been growing quietly in the background throughout Europe, became news last month when the Bank of Japan, the Japanese equivalent of the Federal Reserve banking system, announced that, starting February 16, it would pay minus 0.1% to Japan’s lending institutions on all new money deposited into the central bank’s reserve accounts.  (The central bank will pay 0% on deposits required for regulatory reasons, and will continue to pay +0.1% on existing deposits.)

For the past year and a half, the European Central Bank has been “offering” sub-zero rates to its member banks—currently charging 0.3% for holding banks’ cash overnight.  The Central Bank of Sweden, meanwhile, leads the world in negative deposit rates, at -1.1%.  The central banks of Switzerland (-.75%) and Denmark (-.65%) also charge dearly for the privilege of loaning money to their governments.

By the end of last year, roughly a third of all the bonds issued by Eurozone governments also carried negative yields—meaning that it wasn’t just banks that were willing to buy investments guaranteed to lose money.  French government bonds with a two-year maturity paid investors a handsome -.292%, and German two-year bonds reached a record low of -.348%.  Now Japan is joining the fun, with two-year bond yields at minus 0.85% and bonds with 5-year maturities “paying” a negative .08%.  This is the obvious reason why global investors are flocking to Treasuries and dollar-denominated bonds. The yield spread between U.S. corporate bonds and the bonds issued by foreign countries have seen a dramatic rise over the past 12 months.

Negative payments are considered to be a particularly effective way to shoo money out of the parking lot and force banks to start lending it into the economy—driving up the supply of available money and thereby driving down rates.  It’s a form of economic stimulus to everybody but the banks themselves, and also lowers the value of the currency—which, in turn, stimulates exports and raises profits of companies doing business overseas.  A double stimulus, if you will.

About the Author: Bob Veres has been a commentator, author and consultant in the financial services industry for more than 20 years.  Over his 20-year career in the financial services world, Mr. Veres has worked as editor of Financial Planning magazine; as a contributing editor to the Journal of Financial Planning; as a columnist and editor-at-large of Dow Jones Investment Advisor magazine; and as editor of Morningstar’s advisor web site: MorningstarAdvisor.com.

Mr. Veres has been named one of the most influential people in the financial planning profession by Investment Advisor magazine and Financial Planning magazine, was granted the NAPFA Special Achievement Award by the National Association of Personal Financial Advisors, and most recently the Heart of Financial Planning Distinguished Service Award from the Denver-based Financial Planning Association. 

Sources:

What you need to know about the Bank of Japan and negative interest rates

By The Bank of Japan brought the thunder Friday, shocking investors and economists after it pushed a key interest rate into negative territory in its latest attempt to reinflate the country’s economy.

Negative Interest Rates – QuickTake

Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero and kept them there for more than a year. Now Japan is trying it, too.

Draghi’s Signal Adds $190 Billion to Negative-Yield Universe

With his confirmation that policy makers discussed cutting the region’s deposit rate, Mario Draghi extended the euro area’s negative-yield universe by $190 billion. Those comments by the European Central Bank chief on Thursday sparked a rally that left yields on German sovereign securities negative for as long as six years, and pushed Spanish and Italian two-year yields below zero.

Bank of Japan’s Negative Interest Rate Decision Explained

The Bank of Japan pushed interest rates below zero Friday, after years of keeping them at the lower end of the positive range. The negative rates will be imposed on reserves worth about 10 trillion to 30 trillion yen initially and will apply only to new reserves that financial institutions deposit at the central bank, according to people familiar with knowledge of the matter.

Japan’s Bond Yields Plunge to Records on BOJ’s Minus Rate Policy

Japan’s bond yields dropped to unprecedented levels after the central bank adopted a negative interest-rate policy on Friday, while maintaining its record asset purchase plan. The benchmark 10-year yield touched 0.09 percent, falling past the low of 0.19 percent set on Jan.

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