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Negative interest rates?

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Negative interest rates? Empty Negative interest rates?

Post by confuzzled dude Thu Feb 19, 2015 10:41 am

To the long list of economic mysteries can now be added interest rates. They’ve been at rock bottom, as everyone knows. But now we’ve encountered something novel: negative interest rates. Lenders are actually paying for the privilege of allowing someone to borrow their money. It’s occurring outside the United States, and the Federal Reserve’s next move is expected to be raising rates. Still, there’s no ironclad reason it couldn’t happen here.

Low rates are old hat. Here’s what Bloomberg showed as of this column’s publication: Deposit rates for U.S. savers averaged 0.73 percent for one-year certificates of deposit and 1.5 percent for five-year CDs. On a 10-year U.S. Treasury bond, the yield was 2.12 percent. Abroad, some rates were lower. German 10-year bonds were 0.38 percent, British 10-year bonds were 1.8 percent and Spanish 10-year bonds were 1.6 percent.

Meanwhile, borrowers benefit. Rates on five-year auto loans were 3 percent; on 30-year fixed rate home mortgages, rates were 3.8 percent. But negative rates? How can that be?

In practice, here’s what happens. Bonds are traded on markets, just like stocks. Their prices can rise or fall depending on economic conditions or political events. When the price of a bond rises, its interest rate falls. Consider a $1,000 bond that was initially issued with a 3 percent interest rate. If the bond’s market prices subsequently rises to $1,500, the bond’s effective interest rate drops to 2 percent.

This is how bond interest rates can turn negative. If a bond’s price rises high enough, its original interest payments won’t cover the bond’s full market cost. “I buy a bond for $1,000 and get back $950 -- that’s a negative interest rate,” says Moody’s Analytics economist Mark Zandi. In January, as much as $3.6 trillion worth of government bonds -- mostly European and Japanese -- had developed negative interest rates, estimate London-based analysts for JPMorgan.

Broadly speaking, there were two explanations for this, though they are not mutually exclusive.

The first is that negative interest rates, though unexpected, result from the easy-money policies of government central banks. Their bond-buying (known as “quantitative easing,” or QE) has poured money into financial markets, driving down rates. Although the Federal Reserve has halted new bond-buying, the Bank of Japan and the European Central Bank (ECB) continue their programs. The ECB has pledged to buy $1.3 trillion of bonds by September 2016.

The second explanation is that the weak world economy has quashed inflation and the demand for credit. Businesses don’t want to expand; consumers fear too much debt. Weak global demand could produce a broad-based fall in prices (”deflation”), oil being a harbinger. Depending on deflation’s severity, negative interest rates could then be profitable because investors would be repaid in more valuable money.

confuzzled dude

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