Mad Hatter: Would you like a little more tea?
Alice: Well, I haven't had any yet, so I can't very well take more. March Hare: Ah, you mean you can't very well take less.
Mad Hatter: Yes. You can always take more than nothing.
Alice's Adventures in Wonderland, Lewis Carroll
The gilt market has been stunningly strong this year. Despite commencing the year on a 2% yield, returns have been almost 17%. Disappointing global growth, Brexit, and the BoE's latest rate cut have shriveled yields. Levels of UK bond yields may be destined to join those in Japan and much of Europe.
To borrow once again from Carroll, negative rates 'turns up down and down up', as traditional thinking gets spun on its head. For instance, a Swiss canton has been vocally encouraging its taxpayers not to be too hurried in settling tax bills. In Japan sales of safes have gone through the roof (as they have started to do in Europe) as individuals hoard cash. In Denmark, the homeowners dream of receiving a monthly check from their mortgage company has finally become a reality. Welcome to the world of the Mad Hatter!
Central bankers are used to the idea that lowering interest rates stimulates economies. However, as interest rates approach zero and turn negative there may be evidence emerging that rate cuts lose their stimulative potency. In fact, may even become deflationary. At this stage, the hard evidence is limited but the anecdotal evidence can't be dismissed out of hand. For instance, zero interest rates seem to be keeping inefficient businesses alive. For years, we have spoken about unprofitable Japanese 'zombie'; companies that have been kept alive by their bankers. In a negative interest rate environment, do loans need to be serviced?
Equally, savers may react to lower rates by lifting their savings. In economic theory low returns should deter saving and encourage spending. However this ignores the time constraints individuals face during the main saving period of their lifecycle. This is a particularly pertinent consideration during a protracted period of low rates. A financial planning rule of thumb is that a 1% fall in investment returns necessitates a 20% increase in saving. There is some tentative evidence emerging that saving rates are indeed increasing as return expectations fall: