Why aren’t negative interest rates spurring global growth?
ECONOMISTS say the negative interest rate policy is one of the few weapons left in the central banks’ armoury to jumpstart their economies.
Vasu Menon, vice-president and senior investment strategist at OCBC Singapore, says implementing negative interest rates smacks of desperation on the part of central banks. “It has given rise to the impression that central banks are running out of ammunition, so they are turning to negative interest rates to try and stimulate the economies.”
Advanced economies find themselves in uncharted territory. One of the reasons these tools are not working is because of the uncertainties they created in the market.
Dr Yeah Kim Leng, professor of economics at Sunway University Business School, says the worry about how much lower it can go has resulted in the unexpected response, which has gone against economists’ predictions. That uncertainty is compounded by other factors.
“First is the ageing population, which is growing around the world, where we face the issue of depopulation. When a country’s population ages, there are more pensioners and savers. That actually translates into more savings and lower interest rates. That is one of the reasons interest rates are low — people are saving more. So, there is excess savings.
“When the economy is weak, there is a lack of opportunities to invest. There are overcapacities in many industries because of low or weak demand. We are compounded by the fact that advanced economies are already fully developed.
“All the infrastructure has been developed, so there are limited infrastructure opportunities. This is compounded by the fact that they recently came out of the global financial crisis, so they are still deleveraging from very high debt levels.
“While low interest rates are supposed to stimulate more debt and get people to borrow more, they are not because they are already borrowing to their limit. That is another structural problem, why low interest rates have not worked.”
Political shocks such as Brexit, threats of more attacks by IS and low global oil prices have compounded the effectiveness of these fiscal and monetary policies, says Yeah. This creates an unusual situation where shocks can come from both the real economy and financial assets.
“They are all interrelated partly because of globalisation as it can be transmitted instantly. Because of the linkages in the real economy through trade and investment, it will also have another round of so-called secondary spillover effects and financial linkages that make the economic system even more unpredictable and vulnerable. That is why the International Monetary Fund has called the global economy fragile for many years,” he says.
But it is too early to tell. Yeah says it typically takes up to two years to see the full effects of monetary policy. “Under normal circumstances, the lag effects of monetary actions are about four to eight quarters. So, it takes one or two years to manifest in the economy.”
What can investors do?
IN view of lower expected returns stemming from the negative and low rate environment, should investors take on more risk to compensate for loss of income, or less risk due to the increased volatility?
Experts say they should take on a calculated level of risk and diversify over time, geographical locations and types of instruments.
“We need to ensure that when we take more risk, it needs to be calculated to achieve balance between volatility and returns. Assets with low volatility and decent returns, for example, bonds, real estate investment trusts and high-dividend-yielding equities will still be better options in taking slightly higher risk to compensate loss of income,” says Ahmad Najib Nazlan, CEO at Maybank Islamic Asset Management at Maybank Islamic Asset Management.
“Furthermore, real returns or the spread between these so-called low risk, low yield assets are still relatively high against the negative interest rate for the risk-free assets. Hence, it will always be relative to the risk-free rates and risk appetite for investors. But generally, investors are willing to take lower returns with less risk during periods of uncertainty.”
Affin Hwang’s Ng says as a fund house, it takes prudent risks. “We recommend that investors asset allocate as clichéd as it sounds. For the average Joe, you can still have more allocation to equities, between 50% and 70%. The types of equities will be tilted towards the safer, conservative dividend-quality sort of equities.
“Small caps should always be a satellite strategy. Your core portfolio will be your income fund and then equities will be your evergreen fund. For excitement, we recommend the small-cap or Japan fund. This should take up only about 10% in a satellite strategy.”
Chang says unit trust funds ensures sufficient diversity and lower risk. “For instance, Asian high-yield corporate bonds are yielding about 6.58%. But instead of taking on single company credit risk investing in one bond, investors can and should consider diversity via a fund where a typical high-yield asset manager is invested in 200 issuers with a target yield of more than 6% per annum.”
He recommends investors place 20% into preservation yield assets, 60% into maintenance yield assets and 20% into aspirational yield assets, which are generally more volatile and take on more risk than instruments classified as maintenance yield assets. A simpler approach would be through a fund with global multi-asset income, which is widely available in Malaysia.
“Preservation yield [for example, developed market investment-grade bonds] means accepting a lower yield, but it provides downside protection in adverse market events. Maintenance yield [such as investment-grade corporate bonds] forms the bulk of the yield opportunity. It provides a good balance of yield and risk,” says Chang.
“For aspirational yield [for example, US dollar-denominated Asian high-yield bonds, US high-yield bonds and emerging market government bonds], it is an attempt to enhance overall yield while taking on higher but measured risks.”
This changes your retirement planning
AS low returns from assets are expected, saving for retirement today will become more challenging than ever. Investors will have to save twice as much money or make their money work harder to reach their income goals in their silver-haired years.
In a letter to shareholders in April, BlackRock chairman Larry Fink was quoted as saying that “not nearly enough attention has been paid to the toll these low — and now negative — rates are taking on the ability of investors to save and plan for the future.
“People need to invest more today to achieve their desired annual retirement income in the future. For example, a 35-year-old looking to generate US$48,000 per year in retirement income beginning at age 65 would need to invest US$178,000 today in a 5% interest rate environment.
“In a 2% interest rate environment, however, that individual would need to invest US$563,000 (or 3.2 times as much) to achieve the same outcome in retirement. This reality has profound implications for economic growth: consumers saving for retirement need to reduce spending if they are going to reach their retirement income goals, and retirees with lower incomes will need to cut consumption as well.”
Challenges are already beginning. The Employees Provident Fund recently announced a 36.21% decline in investment income for the first quarter of this year, compared with the same period last year, due to the poor performance of global and local equities. What can those planning for retirement do?
Kam Teik Guan, financial planner at IPPFA Sdn Bhd, recommends switching out of local equity funds that have performed very well thus far and placing them in gold funds instead.
“Some of the local equities are getting expensive and may see more volatility. I recommend switching to gold funds for about 1 to 1½ years because the price is discounted now and considered a safe haven,” he says.
“When gold prices increase and we see gains, we will switch back to equities. That is what I am recommending all my clients to do now, regardless of what their goals are.”
For those who are planning for retirement in the next decade or two, lower returns means they will either have to earn more, invest more or save more. Kam recommends looking for higher earnings.
“Saving more is easier said than done. If an investor has one or two decades to retirement, there are other financial commitments as well. Therefore, as a practical means, it will be easier to find alternatives to earn more rather than trying to save more,” he says.
“There are many who are having difficulty saving because of their financial commitments. A higher cost of living also translates into lower disposable income. The cost of inflation is increasing, making saving almost impossible. By earning more, which results in higher disposable income, there is the possibility of savings, which in turn can be invested.”
How low will interest rates go?
MANY expect low and negative rates to continue for the next few years, but they also believe these rates won’t last forever. Vasu Menon, vice-president and senior investment strategist at OCBC Singapore, says this policy tool can be treated as a signal to the markets that the central bank intends to do whatever it takes to stimulate the economy.
“Central banks may cut rates, but not go too deep into negative territory. There isn’t a lot of precedent to show that it is effective. They are also testing the market,” he adds.
“It shows they are serious about preventing a financial crisis. I don’t think they intended to stimulate the economies only when they cut, it is partly signalling too.”
The longer-term impact is unknown at this point because there are no historical comparisons to be made. Hence, the experts differ on whether the negative interest rate policy will be the bedrock of the next global financial crisis. Menon believes the global economy is not at the point where it is a cause for concern.
“If you look at the world, negative interest rates are not so negative as to create a financial crisis. While pension funds and all may have to relook at their [investment] mandates and go into slightly risky investments, I don’t think they are taking such great risks to the point where they are putting their money in big risk,” he says.
At the end of the day, governments must play a key role alongside central banks, says Menon. “Central banks are doing much more than they should and that is the reason why they have kind of run out of options. Basically, you can hear the likes of the Bank of Japan and the European Central Bank telling their governments that they should step up and spend. Running the economy is not just the job of central banks. While they run monetary policy, the economy is also driven by fiscal policy. So, there is a push for governments to do more.
“Fiscal policy has really been lacking. A lot of governments have not been spending money, partly due to the fact that many of them spent too much in the past and are now tightening their belts.”
In Japan, Prime Minister Shinzo Abe is expected to announce his plans for a large stimulus programme this month that will include government loans, direct spending and public-private financing. The programme is expected to be valued at ¥20 trillion.