What Negative Rates Mean To The Average Investor


What Negative Rates Mean To The Average Investor


While many financial investors are calling for interest rates to be lowered in the hope it will force the share market to rise, John Lonski, chief capital markets economist at Moody's Analytics, doesn't agree.

He says a drop in interest rates, especially to below zero will not instill confidence in the economy but will make the financial markets nervous, leading to a drop in borrowing and spending.

In theory, negative rates should make borrowing more attractive, both for consumers and businesses, however Lonski says if people think the economy is tanking, they may hold onto their money instead of spending it on goods and services.

"The mere talk of negative rates could discourage businesses and consumer from spending as much as they would," he says. "That could depress earnings."

Nick Nelson, head of global and European equity strategy at UBS, agrees and says another problem is that low rates have made stocks more expensive than their historical average, which means equities as an alternative to bonds is no longer attractive.  

"Many people are being pushed up the risk spectrum," he says. "The market is in a stretched situation, where bond like equities are trading at very expensive valuations."

"Dividends are considerably higher than what most companies can borrow at. If a company's cost of borrowing is lower than the dividend yield, then they could re-gear their balance sheets by issuing debt and buying back shares."

Lonski says "savers" would also be at a disadvantage in a negative-rate environment. "It's hard enough to make money in a savings account today, but if rates are effectively zero, then it will be impossible to generate any return on cash. That means that either people just won't be able to save enough or they'll have to take on more risk than they may like, he says.

If a negative rate financial environment was to prevail, Ashwin Alankar, Janus Capital Group's global head of asset allocation and risk management, says it would be advisable to hold more money in cash. He says if the U.S. goes rate negative, the global economy will be tossed into such uncertainty that investing money into anything else would be a risk.

"We're navigating waters we've never traveled on before," he says. "So it's not the best time to load up on risk. You might think that it would be stupid to say 'cash is king,' but cash is king when your other option is taking on too much risk in the markets and where there's no academic theory on what happens when rates go negative."

Alankar says "There's not a lot of historical evidence to learn from. We would have to see how it plays out."

 

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