Here are some thoughts and opinions on negative nominal interest rate. I am not economist versed in fiscal or monetary policy by trade so I only seek to write to share some perspecitves.
June 2019 – Negative Interest Rate Bound
Thoughts: Yields can always go more negative (especially on a relative basis) but the sensitivity of bond price movement relative to yield, also known as bond convexity, will likely be substantial at negative nominal rate.
NIRP in Non-US Market: As the market starts to price negative rates here in the US (it actually did already back in March 2020 when the one-month and three-month Treasury bill yields turned negative in the last week of that month), European Central Bank (ECB) and Bank of Japan (BOJ) both has embarked on this negative interest rate policy (NIRP) for some years now, in 2014 and 2016, respectively.
Capital Flow Direction: Negative US interest rate also has the implication on the direction of international capital flow to/from the US – as a lot of institution investors and sovereign funds are allocated the bond portion of their portfolio to US Treasury b/c it’s currently delivering RELATIVELY higher nominal return (relative to negative -0.25 to -1% return to Japnese and European gov’t bonds).
Change in capital flow direction would have profound implications for our currency, as well perhaps, geopolitical impacts as well.
Investment Implications: Below zero rate is therefore NOT about INCOME but all about CAPITAL GAIN. Furthermore, it’s also about how you fund it. If short-term rates are more negative (which tha decent % of the multi trillion $ global bond market are right now), negative yielding bonds are still a positive carry (on a relative basis). Though one has to wonder the implications on valuation when analysts around the world start crunching their DCF analyses based on this implication.
Housing Market:
On one side of the logic, you can argue that negative interest rate will further dampen the 15Y and 30Y mortgage (of which the mortgage rate has been on a downward trend in lock-step with federal funds rate (FFR) with some discrepancy). For example, if FFR goes into -0.50%, then the 30Y could settle at or near 2% positive range and so forth so that might be a good thing for the real estate market assuming in conjuction there is sound fiscal policy to supporting mortgage lending).
Further, from an investor’s logic perspective, if you are to pay $ to store $ in the bank, you will likely and logically park your $ in perceived safe havens (gold/silver/commodities, equity and/or housing). In essence, it could push housing price relatively exponentially in the short-term.
On the other side of that logic is that with NIRP, banks are further incentize to lend including to mortgage borrowers (b/c they have to pay $ to central bank to store their reserve over there) to borrowers but the challenge here is depositors are less incentize to deposit their $ over there (b/c they have to pay to store their $ at the bank, instead of getting some x% of interest pay from it).
In our short history of NIRP (only Bank of Japan and European Central Bank have embarked on NIRP thus far in 2010-2020 period…for now) we can observe that housing price index has continue to show positive growth but could very well. (1) was when ECB embarked on NIRP and (2) was when BOJ embarked on NIRP.
Last time I checked, 10Y German mortgage rate is in the sub 1% category…as a comparison a 30Y rate is ~3.50% now, 15Y rate is ~3.00% and 10Y ARM is ~3.25% today (May 2020).
But please note, NIRP is a relatively recent concept so our short history does not provide any true indicator of what’s the come and the short-time frame brings into question Twain’s infamous quote, “history does not repeat itself, but it does rhymes often.” Or not.
Intersection notepad 