What Do Negative Interest Rate Policies Mean for Investors?

Central banks around the world are developing a newfound fondness for experimenting with negative interest rate policies (NIRP) — despite unknown consequences and what appears to be a chilling effect on financial markets. It’s a topic PIMCO has been following closely in recent months (see our paper, Negative Interest Rate Policies May Be Part of the Problem.)

PIMCO believes there are very important differences in terms of the impact on the financial system when central banks are reducing policy rates into negative territory versus lowering positive rates. The pressure on the financial sector became more acute when the European Central Bank (ECB) and Bank of Japan (BOJ) joined central banks in Sweden, Denmark and Switzerland in instigating negative interest rate policies and suggested they were prepared to do more.

Banks under stress

Banks, in particular, have borne the brunt of these actions. Because they are unable to pass on negative interest rate costs to their clients, bank profits have come under pressure. With banks no longer able to rely on profits to recapitalize themselves, we’ve seen a tightening of lending standards, particularly in some of the more fragile banking systems in Europe.

VIEW ALL

View all

Spillover effects

Consequently, we’ve seen a new wave of stress spill over into other sectors of the economy, with credit spreads widening. The cost of borrowing for many sectors has actually gone up and credit availability has declined.

Heightened potential for currency wars?

There are reasons to be concerned about the external macro effects. Certainly, many negative interest rate policies — particularly in the case of some of the smaller central banks — have been primarily designed to weaken their respective currencies. As large economies’ central banks, like the ECB and BOJ employ these NIRPs, it raises the risk of offsetting reactions by other large economies, raising the specter of currency wars.

This creates greater volatility and market dislocation. It also creates the real possibility of a backlash in terms of trade tensions if a country is perceived to be using NIRP to gain an unfair advantage by manipulating the price of its currency.

Implications for investors

Negative interest rates may also act to increase risk aversion. As yields on government and other high-quality bonds are pushed into negative territory, holding these bonds represents a guaranteed loss of purchasing power if held to maturity. The response of some investors will be to pull back and take less risk. Others may be encouraged to take more risk to compensate for the loss of income.

What are the alternatives for global central banks that need to stimulate their economies? Monetary policies focused on easing credit conditions more broadly — buying credit-related instruments such as bank loans, for example — may prove far more effective at easing financial conditions than NIRP, in PIMCO’s view. 

PIMCO’s Mather discusses the potential consequences of negative interest rate policies for the banking system and the broader economy.

For timely insights into the macroeconomic factors affecting markets and investors, click on the PIMCO Blog.

By Scott A. Mather

May 9, 2016

Scott A. Mather is a managing director and chief investment officer of U.S. Core Strategies; he is based in Newport Beach, California. 

Disclaimer: All investments contain risk and may lose value. Investors should consult their investment professional prior to making an investment decision.

This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. © 2016 PIMCO

PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Asia Pty Ltd (501 Orchard Road #09-03, Wheelock Place, Singapore 238880, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia) offers products and services to both wholesale and retail clients as defined in the Corporations Act 2001 (limited to general financial product advice in the case of retail clients). This communication is provided for general information only without taking into account the objectives, financial situation or needs of any particular investors.