February 18, 2015

AND THE RATES ARE STILL USURIOUS:

A new economic mystery: negative interest rates (Robert J. Samuelson  February 18, 2015, Washington Post)

[B]orrowers benefit. Rates on five-year auto loans were 3 percent; on 30-year fixed rate home mortgages, rates were 3.8 percent. But negative rates? How can that be?

In practice, here's what happens. Bonds are traded on markets, just like stocks. Their prices can rise or fall depending on economic conditions or political events. When the price of a bond rises, its interest rate falls. Consider a $1,000 bond that was initially issued with a 3 percent interest rate. If the bond's market prices subsequently rises to $1,500, the bond's effective interest rate drops to 2 percent.

This is how bond interest rates can turn negative. If a bond's price rises high enough, its original interest payments won't cover the bond's full market cost. "I buy a bond for $1,000 and get back $950 -- that's a negative interest rate," says Moody's Analytics economist Mark Zandi. In January, as much as $3.6 trillion worth of government bonds -- mostly European and Japanese -- had developed negative interest rates, estimate London-based analysts for JPMorgan. [...]

True, the sluggish world economy has suppressed price pressures. In the euro zone, consumer prices (minus energy) are up a mere 0.4 percent in the past year. But credit demand, while not robust, hasn't collapsed. A study by the McKinsey Global Institute finds that worldwide credit grew 40 percent from the end of 2007 to mid-2014.

Just because bonds are traded at negative interest rates doesn't mean there's much buying at those rates. "I don't understand why anyone would put up with negative interest rates," says Richard Sylla, a financial historian at New York University and co-author of "A History of Interest Rates." "You could do better by holding cash." Some European banks now charge for holding cash deposits; in those cases, buying negative-interest bonds instead might make sense, says Sylla.

Posted by at February 18, 2015 1:58 PM
  

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