Are Negative Interest Rates A Supernova Waiting To Explode?

Several worldwide central banks, most recently the Bank of Japan, have moved to negative interest rates in an attempt to stimulate the economy. 

The reasoning is that by making it effectively cost money to hoard money, they will incentivize banks to invest in the economy and make loans. 

Bill Gross, of the Janus Global Unconstrained Bond Fund, warns that this may prove to be one of the worst ideas in the history of ideas.

Central Banks Have Been Trending Toward the Low and Even Negative Interest Rates in Recent Years

As the above graph illustrates, interest rates have plunged since the beginning of 2009, and for some banks, have even dipped into negative territory.  There is no sign of this trend reversing in the near future. 

Even in the United States the rates remain at a low 0.5%, with almost no chance of going up in June.

While one would assume that this is a great environment for credit, the situation is not without its downsides and has occasionally pushed into the territory of the ridiculous. 

The WSJ reported on one couple in Denmark that received interest payments on their mortgage. 

Meanwhile, MarketWatch refers to negative interest rates as a stealth tax, pointing out that the government now charges a fee to keep money in its bank.

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Bill Gross Warns That This Trend Cannot Continue Indefinitely Without Serious and Violent Negative Repercussions.

He points out that there are currently trillions of dollars of negative-rate bonds in the world. 

This graph from February shows how many trillions it was just a few months ago:

That’s more than 6 trillion dollars of negative-yield bonds back in February. 

Each of those bondholders was effectively paying their respective government for the privilege of being borrowed from. 

And of course, the number has only grown in recent months.

In a Recent Tweet, Gross Touched on the Following:

• There are now $10 trillion of negative rate bonds in the world.
• Global yields are the lowest they have been in 5 centuries.
• The word he uses to describe this situation is – supernova.
• Supernova references the end stage of a star’s life when it becomes incredibly bright as it explodes and loses the vast majority of its mass.

In simple terms, he believes the current negative-rate situation is a disaster waiting to happen.

This is Not the First Time That Gross Has Spoken on the Matter

He continues to assert that we are in a cycle of expanding credit that has lasted for decades and is now reaching its logical conclusion of negative interest rates. 

He also asserts that this situation cannot keep going on indefinitely.

He does not believe that low rates are stimulating the economy, but that they instead are causing bubbles in various assets because investors want to make decent yields and are willing to accept the risks involved. 

Meanwhile—he asserts—banks, individuals looking for a safe place for their savings, and insurance companies are paying the price for the low to negative rates.

Gross Sees Taking Positions as the Only Solution to the Changing Climate:

• He says that annualized investment gains are a thing of the past.
• He also says that investors of sense will have to admit that the market works differently now and take new actions as a result.
• Shorting corporate credit is one of his suggestions as is buying volatility, or keeping it liquid with cash.

He believes that the market is fundamentally changing, and to maintain principal or make capital gains, the investor will have to change tack as well.

Meanwhile, Gross’s Fund is Doing Quite Well For Itself

As the graph above shows, Gross’s Janus Global Unconstrained Bond Fund (JUCIX) has been growing all year. 

According to Bloomberg, it has beaten out 72% of Bloomberg peers by going up 3.2% in the last six months.

Gross’s Management Has Brought Returns

The bond fund has achieved a 2.2% return since Gross’s takeover in October of 2014.

Inflow Has Been Strong as Well

In the biggest inflow since the end of 2014, investors contributed $144 million to the fund this May.

Conclusion

In today’s global market, negative interest rates are a reality, and wherever they strike they turn everything topsy-turvy. 

Suddenly, like the couple in Denmark, people are paid to borrow, and bondholders are charged to loan. 

Simply parking money in the bank can cause it to depreciate.

Does this mean, then, that everyone will pull their money out of the banks and go back to that old standby, the mattress? 

It hasn’t happened yet, but Gross raises some valid points. 

If the central banks do not find a better solution than negative interest rates, the market may well be fundamentally changed.

So don’t go stuffing all your money in the mattress just yet, but do pay attention to interest rates and the effect they have on you and your investments. 

You don’t want to be caught off-guard if and when the supernova hits.