Down the Rabbit Hole

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Each year in our summer issue, we ask a group of the region’s leading wealth managers to help our readers navigate financial waters by responding to a question.

How would negative interest rates in the U.S. affect investors? Leading wealth managers respond…

James Armstrong

Henry H. Armstrong Associates

Negative interest rates punish the saver, and savers are critical to U.S. capital formation and economic health. China, for example, gained economic power in part from its high savings rate. If thrifty savers were to PAY money, rather than EARN money, on their savings, the psychological impact would be profound. People with savings would find a negative return so unpalatable that they would be forced into riskier assets to earn a positive return. Retirees who rely upon savings to fund their expenses would be forced to cut back consumption. By contrast, borrowers, rewarded with very low interest rates, would tend towards maximum borrowing, and as a whole we might again see defaults and disasters, just as we did in 2008. As a result, capital formation in the U.S. would suffer. Negative interest rates are a risky experiment that the U.S. should avoid.

Linda Duessel

Federated Investors

The European experience offers perspective that can be boiled down to this: volatility likely would rise, as would the premium for dividend-​paying and other “safe’’ stocks. That’s because low-​to-​negative yields tend to create a sort of market schizophrenia, with savers shifting into both riskier assets, i.e., stocks, and the safest of assets, i.e., cash, even though the latter results in a loss. This unintended consequence — and there are always unintended consequences to extraordinary policies — means instead of fueling desired inflation, negative rates tend to be deflationary, just as negative “real” rates, which have long been around, tend to slow growth. How? By penalizing savings, which generally equates to investment, which drives productivity and growth.

Robert Y. Kopf, Jr.

Smithfield Trust Company

Theoretically designed to act as an economic catalyst, negative interest rates are meant to incentivize consumer borrowing, spending, and investing. With that being said, this abnormal policy may have quite the adverse effect on the average American investor. Negative rates would drive down bond yields and further depress retail savings accounts, punishing the prudent retiree and saver. Pension funds would be forced to take on greater “risk” to maintain their “funded” statuses, while insurance companies would most likely begin increasing customer premiums to cover the costs unfunded by the fixed income markets. From the perspective of the typical investor, the potential economic spark provided by negative rates may unintentionally “burn a hole” in the average American’s retirement.

Joseph Scarpo

Private Wealth Advisors

Negative interest rates reflect dire economic conditions. In this environment, the behavior of savers changes: money is removed from the banks and either spent or invested in some alternative manner. If the money is spent, economic conditions improve resulting in a period of prosperity. If the money simply moves from a secure position to a riskier investment, market bubbles can form, which ultimately results in economic losses and a continuation of the dire conditions that initiated the negative rate environment. We believe the psychological impact of negative interest rates along with poor economic conditions would usher in a prolonged period of underperformance for the U.S. equity markets. We prefer to see fiscally responsible leadership focused on rebuilding our infrastructure, boosting employment and driving economic prosperity.

Peter F. Mathieson

Fairview Capital Investment Management

We believe investors would respond poorly to a U.S. negative interest rate policy (NIRP). Central banks embrace NIRP as an unorthodox mechanism to stimulate demand when traditional monetary policy proves ineffective. The post-​financial crisis zero interest rate policy hasn’t worked around the world due to structural imbalances of thorny matters such as demographics, labor inflexibility, and political intransigence. Shifting to NIRP leads to the classic metaphor of John Maynard Keynes of “pushing on a string;” thus far it hasn’t proven worthwhile in other nations that have adopted it. Investors seeking income already have been forced to extend further on the risk curve, whether it be through longer maturities, lower quality, or different asset classes. U.S. NIRP probably would only exacerbate the issue.

Mike Kauffelt

Bill Few Associates

An often-​misattributed quote is, “compound interest is the greatest invention of mankind.” Whoever deserves credit for the quote would turn in his grave at the idea of negative interest rates. The consequences of negative interest rates cannot be fully known, but they would certainly pervert the natural order of investing. Savings would be punished and borrowing (debt) would be rewarded. Negative interest rates would certainly help governments that have a great deal of debt, making it cheaper to finance their deficits. The thought is that negative rates would also spur the consumer to spend instead of save. I believe that individuals will still want to save. Negative rates will just force them to do it outside of the traditional banking system. My hope is that we do not experiment with a negative interest rate policy.

Jack Kraus

Allegheny Financial

The idea of negative interest rates is appealing to central bankers because hypothetically, banks would increase their lending activity and consumers would rather consume than invest in savings that are declining to stimulate the economy. The other attraction is that intermediate and long rates might decline, thus decreasing the cost of borrowing to consumers and businesses. The risk of unintended consequences is large. Consumers might hoard cash instead of placing it in banks or money market funds. Bank profitability might decline resulting in distress. Earnings on general accounts of insurance companies would decline, leading to higher insurance costs. Defined benefit pension plans would be more underfunded than they are today. The U.S. dollar is the reserve currency of the world and this could impact its status.

George Mokrzan

Huntington National Bank

The likelihood of negative interest rates in the U.S. is low and generally not an issue for investors. Even with an average severity recession, the Federal Reserve has policy options other than negative interest rates such as large scale asset purchases, which are wellestablished and familiar to financial markets. The Federal Reserve could also reduce its Interest Rate paid on Excess Reserves (IOER) to commercial banks. A lower rate paid on this highpowered portion of the monetary base would increase the incentives for some money center banks to use their excess reserves to boost lending and/​or purchase securities, both of which would provide economic stimulus without the imposition of negative interest rates.

Elizabeth Genter

Schenley Capital

We do not believe that Federal Reserve Chair Janet Yellen would employ a negative rate interest rate policy in the U.S. The theory of this policy would be to stimulate economic growth by reducing the borrowing costs for corporations and households, thus encouraging banks to lend, hence freeing up cash. The fear is that the reverse will occur, hoarding of cash. It is too soon to tell if the strategy is actually working in Europe and Japan. This stimulus has and would benefit stocks over all. We have witnessed a 25 percent increase in stock valuations since the start of 2012. The negative strategy may squeeze the profit margins within the financial sector. Although real estate has experienced an enormous boom, with the lower interest rate environment, it is important to make careful long-​term selections within the equity markets.

Thomas L. Wentling Jr.

Wentling Tarquinio Loughney Wealth Consulting Group, UBS Financial Services

Negative interest rates (paying someone to take your money) signal the Queen of Hearts is now making the rules. They began a little more than a year ago in Europe, Scandinavia, and Japan and may perhaps be heading here. When money is lent, it is created and when it is repaid, it is destroyed. This economic recovery is unique in that, in spite of massive reserve creation by the Fed, banks have not lent out those reserves, because there is little demand. Globally, we have seen a general deleveraging, which is deflationary, driving interest rates down. As they pass through zero, no one knows with certainty what it will mean, because it has never happened before. Other than that, no big deal, or not…

Read a longer piece by Mr. Wentling at pitts​burghquar​terly​.com

Dean Kartsonas

Shorebridge Wealth Management

The use of negative interest rates has been in the headlines recently because the central banks in Europe and Japan have adopted this policy in an effort to stimulate economic growth. The rationale for the Federal Reserve (Fed) to initiate negative interest rates would be a sharp deceleration in U.S. economic activity. After the Fed’s aggressive attempts to generate economic growth with quantitative easing and zero interest rate policies, I think investors would view the adoption of negative interest rates as a clear signal that these other policy actions were not successful. This would undermine confidence in the Fed and have negative consequences for financial markets.

Ron Muhlenkamp

Muhlenkamp & Company

Ten years ago, interest rates on saving and short-​term bonds were in a range of 4.5 to 5 percent. These rates were considered normal. Today, these rates are all less than 2 percent. These lower rates have had a devastating effect on retirees and the saver, including pension plans. The lower rates have benefitted borrowers, including the federal government, homeowners with mortgages, and car buyers. It’s hard to find evidence that lower interest rates have boosted either the buying/​building of new homes or the buying/​building of new plants and equipment, which were the stated goals of the Federal Reserve. Lower rates have boosted prices of longterm, non-​callable bonds and some stocks. A move to negative rates would give a second round with similar (but we believe lesser) effects.

H. Scott Cunningham

PNC Wealth Management

A move to negative interest rates would likely cause some investors to panic, convincing them to make rash decisions such as hoarding cash and buying gold. A better choice would be to buy high quality bonds — U.S. Treasuries, U.S. Bonds, Corporate and Municipal bonds— which would more likely provide investors with a positive return while allowing them to avoid the volatility that would likely ensue in other asset classes (such as U.S. Stocks, REITs, dividend stocks, commodities and high-​yield bonds). Of course, the short-​run volatility would create buying opportunities, too. Lower interest rates could ultimately drive stock and bond values higher. What should an investor do? Choose an asset allocation that best meets your unique needs; diversify; periodically rebalance; and be patient. Good advice under any circumstances.

Megan Petruska

McMahon Financial Advisors

Despite the Fed’s implication of four rate hikes when it raised rates at its December meeting, a volatile Jan.-Feb. in terms of credit spreads and commodities prices has delayed further hikes. This seems to reveal just how impactful market volatility is in the Fed’s mind and potentially shows an underlying concern about the lack of oomph in this recovery. So while rising rates seem undoubtedly in our future, the protracted nature of them may be enough to ward off significant asset repricing. The real question is how long the U.S. can plod along and make up for the busting energy markets. If the cycle truly turns, interest rate increases (or a likely lack thereof) won’t drive stock market volatility. On the sunny side, there seems to be plenty of reason to remain optimistic with good jobs growth, a very healthy consumer, and inflation finally edging up in spite of oil’s drop.

Mark Luschini

Janney Montgomery Scott

If negative interest rates were adopted by the U.S. Federal Reserve, it could have a profound effect on investors depending on how it was applied. If it were broadly imposed, then deposit accounts and money markets would likely yield less than zero unless the sponsoring institution subsidized the rate. However, as we have seen from other central banks that have already moved to negative rates, the impact may be limited to just large institutions and banks that hold cash in reserve at the central bank, and, therefore, not apply to accounts held by most individual investors. Indirectly, however, lending rates could rise in order for banks to make up a shortfall in profits otherwise earned on those “unaffected” customer accounts. This could increase borrowing costs for loans on cars to homes and squeeze investor pocketbooks in a more roundabout fashion.

Donald Nicholson

Northwest Savings Bank

The goal of lowering interest rates is to lower borrowing costs, therefore increasing demand for loans. There can be unintended consequences for investors, however, as rates move into negative territory. Investors who are looking for safety generally turn to the short-​term cash equivalents in order to preserve their money and avoid losses. What negative interest rates would effectively do is make even the safest investments far less effective, as interest would then be “charged” and would act as a fee on a short-​term investment. The impact on investors is that they would slowly lose money on their savings, or take additional risks in order to generate any income above zero.

Gregory Curtis

Greycourt & Co.

Negative interest rate (NIRP) policies are designed to force people to spend money because, if they simply leave funds on deposit in banks, the banks will actually charge for the service, rather than pay interest. If you drop NIRP into an econometric model, it will tell you that NIRP is highly stimulative. But people aren’t automatons and NIRP isn’t an econometrics problem, it’s a game theory problem. NIRP makes people nervous because it is so fundamentally at odds with the way a market financial system works, because it is obvious that economic conditions must be very bad for NIRP to be implemented, and because people don’t like to be dictated to by unelected economists. NIRP will have the opposite of its intended effect.

See a blog from Mr. Curtis at pitts​burghquar​terly​.com

Mike Foster

BNY Mellon

Negative interest rates in the U.S. would have widespread implications. Most directly, savers relying on vehicles such as bonds, CDs and savings accounts would receive lower interest income in the future as current, higher-​rate instruments mature. As interest rates decline, longer-​term bonds would appreciate in value. More broadly, negative interest rates would indicate a very soft economy and potentially deflation, both of which would lower the value of stocks, as expectations for earnings growth would be lower. In such conditions, active managers are well positioned to add value to portfolios amidst market volatility.

David Root

D.B. Root & Company

When central banks deploy negative interest rates, it is seen as an act of desperation, signaling that previous policies have failed. Negative rates don’t instill confidence in the economy, and if consumers and businesses are nervous, they won’t borrow or spend. This can fuel deflation, which can lead to lower asset prices and corporate earnings. Stock prices will likely drop if rates fall below zero. And with negative rates, bonds become a go-​to alternative as bond prices appreciate. Likewise, negative rates will depreciate our currency. With several foreign central banks pursuing this policy (i.e. Japan and Europe), we are entering a full-​fledged currency war where the value of gold as an alternative currency becomes more attractive.


PQ Staff

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