European interest rates are edging further into negative territory bringing down Fixed Income yields across the board. Returns on certain investment maturities are now negative from government bonds to junk debt instruments. In the Eurozone, the remuneration of time and credit risk has become a thing of the past. Euro bond investors grapple to capture some short-term capital gain from this downward interest rate trend, knowing full well the losses facing them over the long term by holding these instruments to maturity.
As the European Central Bank (ECB) awaits its new president Mme Lagarde, the rhetoric from its outgoing management is for more accommodation, through lower interest rates, a return to Quantitative Easing, maybe both. Negative rates in Europe seem set to continue past Mr Draghi’s mandate.
It is difficult to see the point of such a policy. If this intervention provides support to European markets on the one hand, it destroys the existing savings pool through negative absolute and real interest rates on the other. Surely, the idea behind any Capitalist system is the creation of wealth through the remuneration of Capital, and not some absurd artificial liquidity injections, which ultimately work to undermine it.
So why has the ECB chosen this approach? Their announced objective has been to stabilize the European financial system. This institution’s policy intervention has also greatly reinforced their direct and indirect monetary control. The ECB oversees the European banking industry as its regulator. It influences bond and other asset prices in European financial markets through its interventionist monetary policy. It provides most of the funding for individual sovereign Eurozone member states.
However, the ECB is now subject to a certain number of constraints. By putting itself in the financial driving seat, this institution is in the spotlight to avoid disorderly European financial markets (a role the Bank of Japan knows all too well), as well as having to contend with internal political resentment to this ‘monetary control’ paradigm. Over time, this situation could trap the ECB into providing never ending accommodative support thereby condemning European savers to suffer from negative interest rates for a very long period of time.
Column by Steven Groslin, Executive Board Member and Portfolio Manager at ASG Capital