For savers and borrowers, investors and businesses, the world has turned upside down. A Danish bank this week launched the world’s first negative-rate mortgage, allowing housebuyers to take a home loan and pay back less than they borrowed. Some savers sitting on cash, by contrast, are being charged to do so. Governments are increasingly paying more to borrow for the short-term than for longer periods. Many companies and governments are borrowing at negative yields — leaving guaranteed losses for investors who hold the debt until maturity.
The upending of normal financial logic can seem baffling. But it has specific causes — and it is sending important warning signals. The cause is years of easing by central banks, through ever lower — and eventually negative — interest rates, and providing abundant liquidity. Yet despite the growing supply of what appears to be free money, the global economy is continuing to slow and a further boost is needed. This inverted world tells us it can no longer only be the job of central banks to provide the booster.
The side effects of so much loose money are also growing. Bank profits will come under pressure from any sustained period where lending rates are below those on deposits; the rising attractiveness of holding cash risks depositors withdrawing their money.
Meanwhile, evidence of a global economic slowdown continue to mount. Germany said growth contracted during the second quarter, while China saw industrial output expand at its slowest pace for 17 years. As expectations for weak growth and low inflation become entrenched, longer-term interest rates are still falling across the world.
Last week, Bund yields reached new lows. This week was the turn of the US. Despite a relatively healthy domestic economy and low unemployment, the yield on 30-year US Treasuries dropped below 2 per cent for the first time ever. The yield curve, where 10-year rates have been below three-month rates since May, extended its inversion, with 10-year rates now below two-year rates for the first time since 2007.
In the past, a yield curve has inverted because central banks wanted to raise short-term rates to curb inflation, even at the risk of a recession. This time, inflation is too low and central banks are on combat alert against recession. Markets appear to reckon that central banks will fail in their bid to achieve higher inflation — hence the upside down yield curve.
Whatever the precise explanation, the world economy needs help, and fast. Monetary policy cannot take all the strain, but governments are still slow to shift to fiscal expansion. This must change. A targeted fiscal stimulus that lifts productivity via growth-enhancing investment should be a priority. Infrastructure upgrades, expanding public housing stocks and targeted tax cuts should all be considered. This is the recipe for a return to more robust growth and inflation.
Germany’s brief rise in yields last week confirms how powerful such a fiscal shift could be. Discussion over abandoning the balanced budget rules to finance green investment sent 10-year Bund yields sharply higher — before the finance ministry stepped in to quash the debate. Germany and others now face a choice. Relax fiscal conservatism or rely on ever looser monetary policy with eventual taxes on savers and rising risks to financial stability. Central banks have already gone to extraordinary lengths to boost demand. Faced with prolonged uncertainty over the US-led trade war, this has not been enough. Rather than testing the limits of monetary policy, governments must now step up.