Let us first set the scene.
Many savers feel that in the years since 2008, they have been the ones who have in essence been “asked” to support one of the key strategies put in place to aid recovery – the imposition of low interest rates.
Maybe that’s why the lead up to the announcement of a US rate hike at the end of last year was greeted with such delight – from little acorns, etc etc.
At least at first. The shine soon wore off, though.
Poor economic news began to filter through, scotching the hopes of further rises in the near future – or, at least in the case of the UK and many other countries, hopes of a first move away from historically low interest rates.
Then things just kept on going from bad to worse. Negative deposit rates are now appearing in many parts of the world.
This manipulation of interest rates is designed to provide an impetus to growth by making money as cheap as chips – or even cheaper. It is a method of ensuring that the banks do not just sit on the money, by making them pay if they do.
Not all bank reserves are affected – for example, reserves required to meet the relevant capital ratios as dictated by the various regulatory bodies are not included. If the banks were not able to make money, we would all be in far worse position. So far so good – good for those looking to borrow, that is.
But what does it mean for the saver, and for those parts of the business world that are impacted by any change in base rates?
The swap rate market
Let’s start by looking at the international banking sector, and movements in the so-called swap rate market.
Swap rates, which reflect the longer term interbank interest rates, tend to be the driver for the actual return that an investor will receive on their cash.
A snapshot of the short- and medium-term rates currently offered makes interesting reading. The table below shows the movement in rates since the middle of 2015 for the three main currencies – sterling, US dollar and the euro.
International Interest Rates:
Inter-Bank Swap Rates Movement
30 June, 2015 to 11 March, 2016
(Source: Bloomberg: Swap Closing Rates 11.03.2016)
In the short term, then, it is unlikely that your deposit account in the high street will see any change in the meagre rates being offered.
It is much more likely that corporate deposits will be hit first.
This could, in turn, impact the profitability of the companies, which may in turn result in a degree of retrenchment – not quite what the strategy is designed to deliver.
Meantime, what we have been seeing for some time now has been a drop off in the yields for both government and corporate bonds. Some may say that this is starting to undermine the very principle behind purchasing a bond – the fixed income it delivers.
So maybe this will make buying bonds no longer an attractive proposition. Bond funds, so beloved by those seeking security, and those with a firm belief in their ability to provide a reliable income stream, may need to keep an eye on investments which in the past they were happy to let run free.
This lack of yield can also be seen when looking to launch a new a structured product. A bond to support the returns is most often the most costly pricing component for a new structure.
Let’s take a five-year bond paying a 5% annual coupon. By forgoing the coupons it is due to pay, this can be priced at a discount. In very simple terms, you would forgo 25%, and that can be used to construct the product return. So if that coupon fell to 1%, it is pretty obvious that the possible product return is going to be lower.
And, looking ahead…
There is little sign that rates will move up in the near future. Likewise, there is little sign that negative interest rates will disappear, and indeed, there is a possibility that this monetary policy will spread to other countries.
Whether this approach will result in the growth that the global economies seek has yet to be seen.
But it is clear that it will have an impact on investment decision-making for the foreseeable future.
It may be new territory for many advisers and investors, but good investment opportunities will still be around. What we must do, though, is temper our expectations with a pinch or two of patience, and a good deal of realism.
That way, even though we may not come out of this low interest rate era as wealthy as we might have hoped, we may come out of it no worse off, anyway.
Penny Lamont is head of product research at IDAD, a UK-based structured product specialist established in 2002.