"Negative interest rates: What they are and what they mean."

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gkaplan
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"Negative interest rates: What they are and what they mean."

Post by gkaplan » Mon Jun 06, 2016 10:22 am

Negative interest rates are a confusing concept. For insight on what they are and what they mean for the economy and investors, we turned to Peter Westaway, Ph.D., chief economist and head of the Investment Strategy Group for Vanguard Asset Management, Limited, Vanguard's European entity....



Negative Interest Rates
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Rick Ferri
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Re: "Negative interest rates: What they are and what they mean."

Post by Rick Ferri » Mon Jun 06, 2016 10:53 am

How does this affect US investors?

Vanguard Total International Bond Index Fund Admiral Shares (VTABX) has an SEC yield of only 0.64% and a 7.6 year duration. The Vanguard Intermediate-Term Government Bond Index Fund Admiral Shares (VSIGX) has an SEC yield of 1.33% and a shorter 5.2 year duration.

International Fisher Effect (IFE) in theory would compensate US investors in international bonds because the value of the US dollar would be expected to increase relative to foreign currencies. However, since VTABX is currency hedged, there will be no benefit to investors from a stronger US dollar.

Personally, I don't see an economic benefit for US investors to be in VTABX, but I know many people feel there is a diversification benefit.

Rick Ferri
The views expressed by Rick Ferri are strictly his own as a private investor and author and do not reflect the views of any entity or other persons.

goldenbb
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Re: "Negative interest rates: What they are and what they mean."

Post by goldenbb » Mon Jun 06, 2016 11:02 am

I would like to see more discussion about how ZIRP and NIRP affect insurance companies and their underwriting. Because I think that's where the rubber meets the road as far as negative rates being a HUGE problem.

mac808
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Re: "Negative interest rates: What they are and what they mean."

Post by mac808 » Mon Jun 06, 2016 11:31 am

They are a precursor to sovereign debt monetization. There's something historical and significant afoot. Watch what happens in Japan over the next couple years as their central bank buys up all their bonds from private investors.

jalbert
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Re: "Negative interest rates: What they are and what they mean."

Post by jalbert » Mon Jun 06, 2016 9:27 pm

International Fisher Effect (IFE) in theory would compensate US investors in international bonds because the value of the US dollar would be expected to increase relative to foreign currencies. However, since VTABX is currency hedged, there will be no benefit to investors from a stronger US dollar.


The Fisher effect is an unproven hypothesis that states that the currency of the country with higher rates should decrease, not increase. This is because higher rates predict a higher inflation rate (or lower deflation rate) of the country with higher interest rates. This would compensate investors in unhedged bonds denominated in a currency with lower rates, as suggested, but it is the opposite movement that has the compensatory effect:

https://en.m.wikipedia.org/wiki/Interna ... her_effect

But events in recent years call the Fisher effect into question. Capital has tended to flow to the currency with higher interest rates, causing the currency to appreciate, not depreciate. In such a case, hedging will protect investors in int'l bonds from losses due to currency exposure. Of course the Fisher effect would posit that this is not rational behavior, and in the end, investors won't be compensated for chasing the currency with the highest interest rates.

jalbert
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Re: "Negative interest rates: What they are and what they mean."

Post by jalbert » Tue Jun 07, 2016 1:09 am

goldenbb wrote:I would like to see more discussion about how ZIRP and NIRP affect insurance companies and their underwriting. Because I think that's where the rubber meets the road as far as negative rates being a HUGE problem.


Zirp and Nirp mean a very low discount rate for discounting future liabilities back to a present value. This is just a way of saying that at very low interest rates, it takes a larger present value to cover future liabilities. (Retirement savers face the same problem, btw).

ryman554
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Re: "Negative interest rates: What they are and what they mean."

Post by ryman554 » Wed Jun 08, 2016 7:42 am

jalbert wrote:
goldenbb wrote:I would like to see more discussion about how ZIRP and NIRP affect insurance companies and their underwriting. Because I think that's where the rubber meets the road as far as negative rates being a HUGE problem.


Zirp and Nirp mean a very low discount rate for discounting future liabilities back to a present value. This is just a way of saying that at very low interest rates, it takes a larger present value to cover future liabilities. (Retirement savers face the same problem, btw).


Does it, though, for retirees? It also means the future liability is lower, if inflation adjusted -- as retirement savings typically need to be. Isn't it the spread between "interest rate / ROR" and "future liability growth / CPI growth rate" that matters? Interest rates alone are but one portion of the equation.

For items like a fixed annuity or some other fixed liability (like a mortgage) then ZIRP and NIRP apply.

garlandwhizzer
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Re: "Negative interest rates: What they are and what they mean."

Post by garlandwhizzer » Wed Jun 08, 2016 11:38 am

Bonds provide two critical things: safety and income. US bonds are in my opinion safer than foreign bonds especially EM bonds not only because they are denominated in our own spending currency but also because our bond markets are deeper, well-regulated, and more transparent than many INTL markets. As for income US bonds currently yield more than bonds of comparable quality in developed markets, some of which now have negative rates. So on both the two important functions of bonds, safety and income, it seems to me that there is no need to diversify beyond US bonds and no concrete gains to be had by doing it. I do see a potential pay off for INTL exposure in equity investing now, better valuations and more diversification in sector exposure, but I see no such benefits in the INTL bond arena. INTL bonds for US investors seems to me a solution in search of a non-existent problem.

Garland Whizzer

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matjen
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Re: "Negative interest rates: What they are and what they mean."

Post by matjen » Wed Jun 08, 2016 11:52 am

garlandwhizzer wrote:Bonds provide two critical things: safety and income. US bonds are in my opinion safer than foreign bonds especially EM bonds not only because they are denominated in our own spending currency but also because our bond markets are deeper, well-regulated, and more transparent than many INTL markets. As for income US bonds currently yield more than bonds of comparable quality in developed markets, some of which now have negative rates. So on both the two important functions of bonds, safety and income, it seems to me that there is no need to diversify beyond US bonds and no concrete gains to be had by doing it. I do see a potential pay off for INTL exposure in equity investing now, better valuations and more diversification in sector exposure, but I see no such benefits in the INTL bond arena. INTL bonds for US investors seems to me a solution in search of a non-existent problem.

Garland Whizzer


^+1 Completely agree with this reasoning GW.
A man is rich in proportion to the number of things he can afford to let alone.

jalbert
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Re: "Negative interest rates: What they are and what they mean."

Post by jalbert » Wed Jun 08, 2016 1:17 pm

Does it, though, for retirees? It also means the future liability is lower, if inflation adjusted -- as retirement savings typically need to be. Isn't it the spread between "interest rate / ROR" and "future liability growth / CPI growth rate" that matters? Interest rates alone are but one portion of the equation.


Positive inflation makes the present value of future liabilities you need to cover larger in nominal terms, not smaller. And it is harder to cover real liabilities that are random variables, than it is to cover deterministic nominal liabilities. If you want ro remove this uncertainty by using a guaranteed real return to cover real liabilities in real terms, such as with I-bonds or TIPs, then you have a zero or negative real rate as the discount rate.

Dead Man Walking
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Re: "Negative interest rates: What they are and what they mean."

Post by Dead Man Walking » Wed Jun 08, 2016 5:23 pm

This perspective was written by a Vanguard employee for Vanguard's website. Dr. Westaway's advice for investors is "to carry on holding a diversified portfolio, which includes negative-yielding bonds." I may be too cynical, but this appears to be a justification for including international bonds in Vanguard's Target Retirement Funds and Life Strategy Funds. Should I add junk bonds (bonds rated below Baa) to my portfolio for the sake of diversification?

DMW

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