Little Positive About Negative Rates

28 May 2015

Standard Life Investments, the global investment manager, suggests that negative interest rates and bond yields could lead to severe distortions of financial markets and an expansion in financial engineering.

The latest edition of Global Perspective examines the growing phenomenon of negative bond yields and official interest rates, especially in Europe and Japan. It concludes that the implications are substantial; for investors, companies and policy makers.

Over the past 12 months negative interest rates and bond yields have become more prevalent across Europe and to a more limited extent in Japan. Previous occasions have been very short lived but this current episode is much deeper, broader and more sustained.

Andrew Milligan, Head of Global Strategy, Standard Life Investments said:

Andrew Milligan

"If the experience of negative nominal yields becomes embedded for a period of time, then there are considerable implications, not just in Europe. For the general public, for example, the introduction of negative deposit rates at banks could eventually lead to a tipping point at which the public may start to hoard paper currency.

"For companies, investors and policy makers, trends are already in place which could lead to severe distortions. There is a risk that negative yields encourage financial engineering; issuing debt with a negative yield could be very attractive for firms who use the proceeds for share buy backs or M&A activity.

"It is debatable whether negative nominal rates do much to promote economic growth and inflation, but they may help stabilise expectations. However, over time negative rates should inflate asset prices, especially equities, residential and commercial property, creating room for portfolio shifts, and eventually bubbles, to develop.

"We warn that negative yields can create more of a gap or divergence between the economic cycle and the asset cycle. As and when the buyer of last resort steps back, bubbles burst."