13 Apr

Ultra-Low Yields in the Developed World Affects Your Investments

WRITTEN BY Russ Koesterich, CFA

Many bonds, mainly in Europe, are trading with a negative yield, meaning creditors are paying in order to lend money. Russ K. explains, providing three implications for investors.

If financial theory is grounded in one principal, it’s the “time value of money,” or the idea that individuals prefer consumption today over consumption in the more uncertain future.

In order to encourage the deferral of consumption, borrowers must pay lenders, and it has always been assumed that interest rates are “bound at zero”. But as has repeatedly been the case since the financial crisis, the theory is being challenged by the practice.

Ultra-Low Yields in the Developed World Affects Your Investments
ECB Refinancing Rate

Market Realist – Ultra-low yields in developed market government bonds mean that the hunt for yield continues.

The graph above shows the interest rate in the Eurozone (IEV) (VGK) since the start of 2014. Interest rates are close to zero, like it is in the US. The difference is, while the US (SPY) could see a rate hike later this year, the Eurozone is still in the process of pumping liquidity (or QE) in the economy. The ECB (European Central Bank) is aggressively buying European government bonds, in the process putting downward pressure on bond yields, which were already low. This is leading to a further dip in interest rates in the Eurozone.

The ECB first cut interest rates, and recently started its own version of QE in order to boost investment and consumption in the beleaguered economy.

Negative yields in the Eurozone and very low rates in most other developed markets (EFA)–including in Japan (EWJ)–will affect your investments. The rest of this series will highlight the same.

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