How negative rates affect economies

Over the last quarter, “we’ve faced an unprecedented period of low interest rates, and many major central banks even broke the barrier of 0% rates,” says Luc de la Durantaye, managing director of asset allocation and currency management at CIBC Asset Management, and manager of the Renaissance Optimal Inflation Opportunities Portfolio.

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Most of these central banks are located in Europe, he adds. “The European Central Bank, Swiss National Bank, Danish Central Bank and Swedish Central Bank have all moved their policy rates below zero, ranging between -0.2% and -0.75%.”

And the Spanish Treasury recently joined the club by issuing short-term debt yielding below 0%.

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Still, there’s hope we’ll remain in an environment of global economic recovery. “[Even] in Europe,” says de le Durantaye, “we’ve seen the currency fall and oil prices fall, and we’ve seen interest rates fall. That should spur an economic recovery.

“If [that] doesn’t happen, you’re left with very few tools to continue to stimulate the economy. You’re already at negative interest rates [and] those can’t go much beyond where they are today.”

Read: Offer global perspective on bond yields

On the domestic front

North American interest rates have remained above zero, but the Bank of Canada recently lowered its rates from 1% to 0.75%. So, “we suspect we’re approaching the limits of monetary policy stimulation. The reason is there’s a level of negative interest rates at which savers or investors will prefer to keep their money under their mattresses, rather than paying for financial institutions to safeguard their assets.”

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• Bank of Canada holds rate steady, for now
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Based on studies, says de le Durantaye, that level is estimated to be around -1%, which, under normal circumstances, would be the cost of keeping your money on hand rather than in a savings account.

If we see negative rates in Canada, he adds, our domestic recovery will be sluggish since people will save more and spend less. “As people age, they also won’t have the capacity to take on more risk,” and will need to save more for retirement because of low interest rates.

Read: Bond yields won’t rise much in 2015

But, due to the continued search for yield, some may look beyond cash and low-yielding sovereign bonds. “They will likely start moving out of these securities and up the risk spectrum into corporate bond[s] and high-yield, high dividend-paying stocks.

“High-yield bonds look attractive since they offer a premium over U.S. and Canadian bond yields. And, while high-dividend-paying stocks, such as utilities and consumer staples, may be expensive today, they may become even more expensive due to the search for yield.”

Read: Cut exposure to REITs, utilities

The risk, he notes, “is the search for yield will push assets’ prices from fair value to overvalued, so that will become a challenge in the investing environment. There won’t be many things that are cheap to invest in.”

Read: Don’t give up income for security

Also, bonds yields in North America may not back up as much as people expect “We’ve gone from 0% to negative interest rates in Europe, and that has drawn bond yields lower. In comparison, North American yields look more attractive.”

Read: Foreign investors turn back to Canada

As a result, says de la Durantaye, “you’re going to have international investors flocking into North America bonds, which is going to help suppress yields in North America. If you think [domestic] bond yields are moving higher, then maybe think again.”

He adds, “With more limitation[s] on the ability to stimulate economies through monetary policy, it becomes even more important to track the economic recovery.”

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