The Absurdity of Negative Yields
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Is “invest” the right word to describe an asset that when held to maturity guarantees a loss of capital?
Interest rates are at historically low levels around the globe. Interest rates are negative in Japan and throughout much of Europe. In this article, we expound on the themes laid out in Negative is the New Subprime, to discuss the mechanics of negative-yielding debt as well as the current mindset of investors who invest in negative-yielding debt.
Over the past few decades, the central banks, including the Federal Reserve (Fed), have relied increasingly on interest rates to help modify economic growth. Interest rate management is their tool of choice because it can be effective and because central banks regulate the supply of money, which directly affects borrowing costs. Lower interest rates incentivize borrowers to take on debt and consume while dis-incentivizing savings.
Regrettably, a growing consequence of favoring lower-than-normal interest rates for prolonged periods is that consumers, companies and nations grow increasingly indebted as a percentage of their respective income. In many cases, consumption is pulled from the future to the present day. Accordingly, less consumption is projected for the future and a larger portion of income and wealth must be devoted to servicing the accumulated debt as opposed to productive ventures that would otherwise generate income to help pay off the debt.
Negative yield mechanics
It’ not only sovereign debt; investment-grade and even some junk-rated debt in Europe now carry negative yields. Even stranger, Market Watch just wrote about a Danish bank offering consumers’ negative interest rate mortgages.
You might be thinking, “Wow, I can take out a negative interest rate loan, receive payments every month or quarter and then pay back what was lent to me?” That is not how it works, at least not yet. Below are two examples that walk through the lender and borrower cash flows for negative-yielding debt.