What are negative interest rates, why they could come to the U.S., and what investors can do about it.
In this episode you’ll learn:
- How negative interest rates are even possible.
- How longer life spans, central bank actions, changing time preferences and the FIRE movement are contributing to negative interest rates.
- What is the paradox of thrift.
- How investors can earn a positive return on bonds even if interest rates are negative.
- What are some indicators to watch for that could signal imminent negative interest rates in the U.S.
- How individuals need to adjust their lifestyles in an era of negative interest rates.
Show Notes
Personal Saving Rate—Federal Reserve Bank of St. Louis
How Interest Rates Affect Time Preference — and Vice Versa by Frank Shostak—Mises Institute
Austrian School of Economics By Peter J. Boettke—The Library of Economics and Liberty
Interest Rates: Naturally Negative? by Joachim Fels— PIMCO Blog
How This Bull Market Will End by Randall W. Forsyth—Barrons
Episode Sponsors
Episode Summary
Negative interest rates are nothing new, but they have yet to make an appearance in the United States. Interest rates are directly related to the cost of bonds. When the price of the bond goes up, the interest rate goes down. The opposite is also true. Financial decisions made by individuals also affect the rise and fall of interest rates. In this episode, David shares some of the reasons why negative-yielding bonds exist, why some investors choose to purchase them, and what indications to look for as precursor to their appearance in the U.S. Be sure to listen to the whole episode!
How people save money directly influences interest rates
While it has been shown that many people prefer immediate satisfaction to delayed or future satisfaction, the concept of a savings glut has an impact on the possibility of negative interest rates. When individuals decide to save money for the future—retirement and the ability to spend more freely and luxuriously later in life—they slow the speed of capital flow in the present. If companies and businesses aren’t seeing a rise or the maintenance of the status quo in spending and consumerism, then their incomes might drop and they won’t have the ability to pay their employees the same amount that they have previously or unemployment will rise. In other words, the paradox of thrift and the time preference of consumers and businesses in spending now versus later influences aggregate demand, the desire to borrow, and the willingness of businesses to invest in capital projects. These are all factors that can influence interest rates, even leading to negative interest rates. While saving is certainly a good thing, a savings glut—wherein it becomes a large and lasting trend—could cause interest rates to plummet.
Why some choose to invest in negative-yielding bonds
David lays out three reasons that investors would be willing to invest in bonds with negative interest rates. First, some believe that interest rates could continue falling—in which case a -2% yield could become a -5% yield, leading to capital appreciation for the bondholder. When interest rates fall, the value of the bonds themselves goes up. David explains that investing in bonds for capital appreciation is more of a speculation with the interest rates—it’s not investing for income.
The second reason is called rolling down the yield curve. Oftentimes short-term rates are lower than longer-term rates. By holding a bond for several years, a 10-year bond will become a 9-year bond which will become a 7-year bond. Even if interest rates stay the same, the gradually shortening of time to maturity by holding a bond can lead to a small amount of capital appreciation due to the upward sloping yield curve.
The third reason to invest in bonds with negative interest rates is that bonds are a safe place to store money long-term. Some investors or companies are willing to pay money in order for their current money to be kept safe and available if something better comes along.
Searching for indicators of impending U.S. negative interest rates
David explains that there are three things he looks for as indicators that negative interest rates are coming to the U.S. First, is that non-manufacturing industries slow down in the same way manufacturing has. Currently, there is a very wide gap between manufacturing and non-manufacturing survey data as reflected in Purchasing Manager Indices (PMI). If the gap narrows through a deterioration in non-manufacturing surveys that could be an indicator of a slowing global economy overall and more negative interest rates.
A second factor that David considers is the earnings expectation of companies and businesses. If those expectations were to lower, then that could be an indication that the U.S. economy is slowing and that more people are saving. The opposite has been true, however. Companies continue to raise their earnings expectations.
The third consideration of David’s is credit spreads. What are investors demanding to own non-investment grade bonds? Those bonds are issued by companies that have a greater chance of default.
Why it might be wise to consider living an asset-light lifestyle
What if negative interest rates do make an appearance in the U.S.? We still need to save for the future, especially when planning for retirement. David suggests becoming less capital intensive—just as companies are investing less capital in new products and services. Take into consideration what you can live without. Simplifying your assets to the essentials allows you to explore what you actually need to live life well. Invest in products and technology that will last you a lifetime—or at least for several years. When the budget becomes tighter due to less cash-flow in the economy, you won’t need to make drastic changes to your lifestyle because you have already simplified your asset holdings. Listen to the episode for more insight into why negative-yielding bonds are growing in popularity and what you can do to prepare.
Episode Chronology
- [0:20] Germany’s government bonds go negative for the first time.
- [2:38] Understanding savings: the paradox of thrift.
- [6:35] The concept of the individual choice and the perceived expense of saving.
- [11:05] The savings glut could lead to negative interest rates in the U.S.
- [14:40] Three reasons one would invest in negative-yielding bonds.
- [18:38] Central banks are influencing the spread of negative-yielding bonds.
- [20:29] What could happen to the U.S. economy if interest rates fell.
- [22:11] Three factors David is looking at for an indication of falling interest rates.
- [25:49] What we can do if U.S. interest rates go negative.
Related Episodes
22: Will Interest Rates Ever Increase?
52: Why Are Interest Rates So Low, Even Negative In Some Places
82: What Assets Return When The Fed Raises Rates
122: Why Negative Interest Rates Are Dangerous
133: Interest Rates Are Rising. Four Things You Can Do
255: With Interest Rates Falling, Why Do You Own Bonds?
260: Is This Why Interest Rates Are Falling and the Global Economy Slowing?
Transcript
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