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Uncommon Sense
March 2016
Are Negative Interest Rates the Next Black Swan?
by Michael Arone, CFA, Managing
Director and Chief Investment Strategist
for US Intermediary Business Group
“We can be heroes, just for one day.”
— David Bowie
Seven years after the global financial
crisis and Great Recession, the global
economy remains mired in growth
purgatory, despite the best efforts of
central bankers. Economic growth
is underwhelming everywhere —
in the US, Europe, Japan and even
China. And now that anemic growth
could be slowing further. As a result,
a dangerous game of chicken is
breaking out among central bankers.
They are vying with each other to
concoct the new monetary policy
that can finally reignite domestic
growth and inflation.
Acting as super heroes sent to save the global economy, central
bankers have tried every existing policy measure. They started
out with lowering interest rates and bond buying (quantitative
easing), and when that didn’t work they reduced rates to zero.
Now, negative interest rate policies (NIRP) have become a
reality and there are whispers in the wind of even more extreme
measures such as flinging “helicopter money” directly to
consumers to encourage them to spend, or to governments for
infrastructure investment. As J.P. Morgan’s Alex Dryden so
eloquently puts it: “We are moving from a low yield
environment to a no yield environment.”1
However, supposedly omnipotent central bankers may want to
consider that NIRP could actually become the next Black Swan
due to unexpected consequences of the latest experiment in
monetary policy. In this new era of aggressive central bank
actions, a quarter of the world’s sovereign debt has negative
yields,2 and Federal Reserve Chair Janet Yellen has said the Fed
has at least considered the idea of negative rates in the US. The
theory behind unprecedented monetary accommodation and
negative rates is they boost financial asset prices and lower the
cost of capital, eventually leading corporations to pursue
greater capital expenditures and consumers, feeling wealthier,
to spend more. Well, that’s the theory, anyway.
Figure 1: Selection of Countries with Negative Bond Yields
Switzerland
70
Germany
58
Japan
57
Finland
50
Netherlands
47
Austria
46
Sweden
45
France
42
Belgium
28
26
Denmark
0
20
40
60
n Percentage of bonds with negative yields
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research,
February 2016.
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Uncommon Sense | Are Negative Interest Rates the Next Black Swan?
Yet as Bridgewater Associates’ founder Ray Dalio recently
pointed out in a note to clients, QE can push asset prices
somewhat higher, but investors and savers will still want to
save, and lenders and borrowers will remain cautious so central
banks are “pushing on a string.”3 I agree, and feel that
demographics and aging populations around the world are a big
and overlooked reason why easy monetary policies haven’t been
enough to trigger the growth we desperately need. It’s possible
that no amount of QE will cause aging populations to consume
rather than save, and that these policies may actually be hurting
the economy.
In fact, since the Fed lowered rates to zero in 2009, the savings
rate has actually trended higher (see Figure 2).
Figure 3: Inflation: Monthly Change in Consumer Price
Index (CPI)
16
12
8
4
0
-4
1970
1977
1985
1992
2000
2007
2016
Source: Federal Reserve Bank of St. Louis. Data shown is January 1, 1970 to January
1, 2016. Consumer Price Index for All Urban Consumers: All Items. Monthly percent
change from a year earlier.
No Pain, No Growth
There are simply no more easy policy choices left. The can has
been kicked as far down the road as possible … yet it keeps
rolling back. We may have to face the fact that easy monetary
policies alone, without structural reform, won’t be enough to
spark global growth.
15% in March 1980.4 Volcker increased short-term
interest rates to previously unimaginable levels to
vanquish inflation. He knew there would be tough
consequences for the economy, capital markets and
financial system. The US economy suffered for a while
longer until inflation was tamed and interest rates could be
lowered. Only then did a real economic recovery gain traction.
This certainly isn’t the first time that we’ve faced tough
challenges. For those old enough to remember, the stagflation of
the 1970s and early 1980s was one of the worst investing
environments in recent history. Rising inflation coincided with
higher unemployment and a slowing economy to create a truly
toxic mix. Similar to investors’ recent experience, the stock
market had some good years and some bad years, but mostly
went nowhere.
Today’s primary economic challenge is certainly not spiraling
inflation, but rather lackluster growth and fears of deflation.
The policy choices will most definitely not be the same, but
that doesn’t mean they will or should be any less painful.
Yet central bankers keep doing the same thing over and over
again and expecting a different result. They have created the
Participation Award economy where everybody gets a trophy,
Enter Paul Volcker, the cigar-chomping Federal Reserve
chairman under Presidents Carter and Reagan who is credited
with breaking the back of inflation, which topped out at nearly
Figure 4: US Population 65 Years and Over: Past
and Projected
Figure 2: Savings vs. Rates
US Gross National Savings Rate as % of GDP
US Fed Funds Effective Rate (%)
24
20
22
Population (M)
% of Population
600
30
16
500
25
20
12
400
20
18
8
300
15
200
10
16
4
100
5
14
1980
1987
1994
2001
— US Gross National Savings Rate as % of GDP
— US Fed Funds Effective Rate
Source: Bloomberg, as of December 31, 2015.
State Street Global Advisors
2008
2015
0
0
1900
n US Population
1950
n 65 years and over
2000
2035
2050
0
— % of Total Population
Source: US Census Bureau, Population Division, December 2012; Demographic Trends
in the 20th Century, November 2002.
2
Uncommon Sense | Are Negative Interest Rates the Next Black Swan?
and nobody is allowed to fail. I think we need a “hero” like
Volcker to step up and make some difficult decisions that could
result in short-term pain, but for long-term gain. The truth is
that in a healthy, dynamic and balanced economy, not everyone
wins. Some must lose. Sometimes the system just needs to be
cleared to build the proper foundation for the next cycle of
growth and innovation. That’s how capitalism works.
US Social Security Administration Total Beneficiaries (M)
65
68
59
66
53
64
47
62
41
2001
2008
Jan
2016
<35 35–39 40–44 45–49 50–54 55–59 60–64 65–69 70–74 75–79 80+
Source: Federal Reserve Survey of Consumer Finances, 2013.
70
1994
3
n Financial Assets ($ Trillions)
Figure 5: Workers vs. Savers
1987
4
0
Therefore, I believe it’s time to stop focusing on boosting
consumption through aggressive and unprecedented monetary
policies, and start focusing on increasing production and
income for an aging population. Monetary policies have
focused only on one group of beneficiaries of lower rates —
borrowers. Central bankers have ignored the negative impacts
that financial repression has on the amount of income savers
get on their money. Compared to the 1930s and 1970s, the US
and other advanced economies are getting much older. As a
result, there are a much greater proportion of older savers
today than at any other time in history. Not only that, they own
a vast majority of the assets and wealth.
Mar
1980
5
1
Today’s problems are different from those we faced during the
Depression Era 1930s or the stagflation 1970s. Additionally,
demographic shifts underscore that solutions that worked
during those time periods probably won’t work now. In the US,
we are a much older nation these days, and the trend is also
evident in many other developed economies. Importantly, the
portion of US households aged over 65 has increased by 3.5%
since the last business cycle peak, and is set to increase by an
additional 6% over the next decade (see Figure 4).
60
6
2
Demographic Challenges and
Different Solutions
Labor Force Participation Rate (%)
Figure 6: US Household Assets by Age
35
These older savers are being penalized by lower rates and we’re
forcing them into riskier assets. And they hate it! This growing
group of wealthy savers has less money to spend because
interest rates are being repressed. I believe this is hurting
economic growth more than anyone realizes.
Heroes Wanted
Until recently, low rates were viewed as a panacea for all that
ails the global economic system. As a central banker, when all
you have is a hammer, everything starts to look like a nail.
That’s why we have NIRP, which was put in place by the
European Central Bank (ECB) in 2014 and subsequently
adopted by Denmark, Sweden, Switzerland and Japan in late
January 2016. Negative rates could even be heading to the US
at some point.
This makes an already tense situation for global financial
institutions worse to the extent that negative rates compress
net interest margins and wreak havoc on savers. Can an asset
be considered risk-free when one must pay the issuer to own it?
In short, there are no risk free-assets in countries with negative
interest rates. Paradoxically, investors may need to take greater
risks with capital that should be risk-free, or save more to meet
future spending needs. Neither consequence supports prudent
capital allocation or economic growth.
Until central banks restore their credibility, it seems likely
that market volatility will continue. Tough choices will be
required, and there will be some winners and many losers. The
next phase of the journey will not be for the faint of heart, so
only heroes and leaders need apply.
— US Labor Force Participation Rate
— US Social Security Administration Total Beneficiaries
Source: Bloomberg, as of December 31, 2015.
State Street Global Advisors
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Uncommon Sense | Are Negative Interest Rates the Next Black Swan?
Notes & Sources:
“Negative Interest Rates, A Modern Policy Error, and the New Bid for Gold,”
Strategas Research Partners, February 12, 2016.
“Increasingly Addled,” Bill Gross, Janus Capital Group, February 3, 2016.
“Hoisington Quarterly Review and Outlook - 4Q2015,” Van R. Hoisington and Lacy H.
Hunt, Ph.D., January 20, 2016.
“The Fed Prepares to Dive,” John Mauldin, February 22, 2016.
“Helicopter drops might not be far away,” FT.com, February 23, 2016.
“The Silver Age of the Central Banker,” Epsilon Theory, February 19, 2016.
“(Monetary) Napalm in the Morning,” Convergex Market Commentary,
February 24, 2016.
“The US Consumer: Research and Results, Demographic Notes: A Boomer Bust?,”
Empirical Research Partners, January 26, 2016.
“Investors seek long-term debt as yields drop,” FT.com, February 25, 2016.
“Record $5.5tn in govt bonds with negative yields,” FT.com, January 29, 2016.
3
“’Helicopter money’ on the horizon, says Ray Dalio,” FT.com, February 18, 2016.
4
Based on year-over-year changes in the Consumer Price Index.
Source: US Department of Labor, Bureau of Labor Statistics.
1
2
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