Negative interest rates are coming to America

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American savers have had it hard enough, earning next to nothing on bank deposits and money market funds.

But could it get worse, with banks here charging depositors interest to hold their money and high-quality bonds yielding nothing at all?

It might seem a curious question, given broad expectations for higher U.S. interest rates, as job growth gathers momentum and the Federal Reservehas openly hinted it is eager to end its seven-year policy of near-zero short-term interest rates.

Yet a collapse in interest rates overseas and the continuing risk of financial shocks is spurring Wall Street economists at least to mull the unlikely prospect of such a scenario developing here.

The specter of negative interest rates has been sweeping across Europe for months. The European Central Bank and those of Switzerland, Sweden and Denmark have set official overnight interest rates among banks below zero in an aggressive effort to encourage borrowing, energize economic growth and stave off deflation, a spiral in which people continually expect prices to fall. 

As a result, some banks in Denmark are charging customers for the privilege of keeping their money in deposit accounts there.


Goldman

Economists at Goldman Sachs Friday explored the possibility that, under unexpected and unwelcome circumstances, rates in the U.S. could slide below zero as well.

The firm concludes that it is “extremely unlikely” that the Fed would move in this direction.

For one thing, the U.S. is growing at nearly the fastest rate among mature economies, which has led the Fed to set the stage for the first short-term interest rate hike in nearly nine years.

Wall Street is debating whether this might occur in June, September or perhaps early 2016. But for now, Fed Chair Janet Yellen’s stated intention and the market consensus is that the next move for rates is up, and likely within the year. If it happens, it will be a modest dose of good news for savers, who could expect to collect slightly more on their money.

Even if damaging financial shocks struck to derail the U.S. recovery or rupture financial markets, a rush to negative rates here appears unlikely. And without negative rates on money banks deposit with the Fed, consumer interest rates would not turn negative. 

Goldman points out that even in the depths of the crisis, the Fed rejected the idea of eliminating the 0.25% it pays banks on their excess reserves kept at the central bank. Policymakers were concerned that it would upend the operation of money-market funds, which are viewed by many as a nearly risk-free equivalent to cash and are far more prevalent in the U.S. than in Europe.

There is also a sense that dropping rates below zero would have limited effectiveness in promoting faster growth, and individuals would likely respond by holding more savings in actual cash currency.

The growth rate of physical currency in circulation has indeed accelerated since the Fed dropped rates near zero in 2008. And this was not pocket cash meant for daily expenses.

“In fact,” Goldman economist Kris Dawsey says, “most of the increase in currency outstanding in recent years has occurred in $100 bills, which are less likely to be used for day-to-day transactions.”

The cost of safety

Still, there are strong global forces suppressing rates everywhere, and it could mean negative rates remain a feature of markets and at least a theoretical possibility here.

Large expanses of the global bond market reflect the gravity of zero-percent rates, as investors intent on keeping their capital safe accept negative yields on bonds – ensuring that over the term of the investment they will get back less than the amount paid.

Researchers at Bank of America Merrill Lynch calculate that a total of $4.2 trillion worth of government debt today yields either zero or carries a negative yield, most of it from Europe and Japan. The most powerful multinational companies are also having money handed to them by investors at virtually no cost.

Apple Inc. (AAPL) this month opportunistically issued $1.35 billion worth of bonds denominated in Swiss francs at miniscule rates of 0.375% a year for 10 years and 0.75% over 15 years.

Apple has some $180 billion in cash on hand, and so it didn’t need the cash. But the chance to grab ultra-cheap capital that it can use to buy back its stock – and thereby save on the dividends it pays on the shares – meant the market was essentially paying Apple to borrow.

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Swiss food giant Nestle saw the yields on some of its outstanding debt turn negative, as investors bid it up in price. The bonds are seen as ultra-safe securities and will be paid off in the form of highly valued Swiss francs.

The idea of paying more for a bond than one will receive at maturity even if all goes well probably seems nonsensical. Yet there are rational explanations.

The negative yield could be viewed as the cost associated with safety for large pools of capital. There are not enough safe assets with yield in the world to satisfy demand for them. Insurance companies and pension funds investing for the long-term needs of an aging society need conservative investments.

As Towers Watson consultants point out, pension assets amount to 84% of global gross domestic product, compared to 54% in 2008. Meantime, while governments have lots of debt, they aren’t adding to the total as fast as in years past, creating some scarcity.

Another reason to accept a negative nominal yield is if deflation is expected. In this event, an investor might expect even the lower amount returned when the bond matures will have more purchasing power than the amount paid for the bond today.

The U.S. is not yet among the countries where deflation appears to be a significant threat, which should mean short-term rates will be slowly dragged further above zero before too long.

But the global deflationary menace continues to keep deposit rates and bond yields quite low – meaning American savers will likely have to deal with unsatisfying earnings on their cash for a while to come.

Source: http://finance.yahoo.com/news/banks-in-europe-are-charging-to-hold-deposits–could-it-happen-here-195532627.html

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