Firstly, what is a negative interest rate?
It is a bond issued by the government or a corporate bond (though less likely and less common) that offers a negative yield. As an example, if a bond cost £100 and the interest rate was negative 1% for a yearly bond, the money you’d get back at maturity would be £99.
Japan has recently gone deliberately negative and Germany’s 10 year government bonds are currently at negative rates, with the UK’s being around 0. The real fallacy in my mind however isn’t people investing in negative yields. There’s a variety of reasons why they would, as I set out in this piece, but by the governments being so ideologically wedded to deficit reduction, in the most counter intuitive way they are contracting demand with threats of deflation and wage stagnation, and across Europe at least chronic under investment and unemployment.
How do negative rates come about and who buys them?
This is both a deliberate attempt by a central bank or government policy, but it can also be due to the nature of people buying the bonds at any one time too.
Some institutions and banks hold bonds as an asset to offset a liability. The intrinsic value of a bond can be seen as the value at maturity plus or minus the interest rate. The central banks have also been buying up government bonds as part of the QE process which has driven the price up and the yield down.
There are also those whom buy bonds with negative interest rates, as they are deemed to have positive returns when held in different currencies, where currencies trade at different prices. The value of currencies changes based on confidence, import/export differences (balance of payments) and interest rates in a country, as every deposit in a given country is held in that currency. This is why I predict that if and when the Euro finally stops printing and issuing €500 notes, that the consequence for the Euro-zone will be a reduction in the interest rate for government bonds.
For more on this and negative interest rates drop me a tweet on @rwscarter or email me on email@example.com .