No positives in going negative for central bankers, says Principal Global Investors


Seema Shah

President Trump has been pushing the Federal Reserve (Fed) to consider cutting policy rates below zero in an effort to stimulate growth and weaken the dollar, however his stance hasn’t gained support amongst other central banks or the Federal Open Market Committee (FOMC).

According to Principal Global Investment Strategist, Seema Shah, the rapid spread of negative yielding debt in the past year, including large chunks of the corporate bond market, has raised profound questions about this unconventional policy tool.

“While it’s generally accepted that monetary stimulus becomes less effective as interest rates fall further, all signs indicate negative policy rates aren’t just less effective, they’re counterproductive”, Ms Shah said.

“Negative policy rates are such an unorthodox policy that, in some cases, they can be interpreted as a sign that the economy is in real trouble, confusing and spooking investors. It may even prompt households and businesses to defer borrowing and investment as they anticipate further reductions in policy rates. In Germany, where the term “Strafzins”, or “punishment rate” is widely used to refer to negative rates, the savings rate has increased in spite of negative policy rates.”

A turn away from rate cuts

Ms Shah went on to argue that, while central banks are still faced with the need to provide more stimulus, they are increasingly turning away from rate cuts, and instead looking to deliver further policy stimulus via balance sheet expansion and forward guidance—and pressuring governments to play their part.

“Recent comments from new European Central Bank (ECB) President, Christine Lagard, suggest adjustments to the ECB’s issuer limits are more likely than further policy rate cuts. Similarly, in Japan, there is unprecedented level of concern about the damaging side-effects of ultra-low interest rates.

“In the United States, the latest FOMC minutes revealed the focus the Fed places on avoiding the problems currently facing the ECB and Bank of Japan. The Reserve Bank of Australia has recently noted that 0.25% is its lower bound for policy rates, beyond which quantitative easing would be the preferred policy choice, while concerns about fuelling the next asset price bubble has prompted the Riksbank to denounce negative interest rates.”

Ms. Shah went on to say, “while this pendulum swing away from negative policy rates may provide some relief to savers, let’s not exaggerate its impact on the market. The only way to deliver a material rise in bond yields is if markets start to anticipate central bank tightening. We are years away from that scenario.”

Ms. Shah asked how investors can best navigate this environment, weighing in that “as well as focusing on high quality assets, investors will need to increasingly pivot asset allocation from traditional developed market fixed income and equities towards emerging markets and alternative investment asset classes, including real estate….overreaching for yield is not your only option,” she concluded.

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