Negative interest rates: how low can you go?


By Vanguard

Added 28th June 2016

Peter Westaway, head of investment strategy for Vanguard Europe, explains why investors should remain invested in global bonds despite negative yields.


Biola Babawale: Negative interest rates: How low can they go? My name is Biola Babawale. I am an analyst on Vanguard's sovereign credit desk. I have with me Peter Westaway, chief economist and head of investment strategy at Vanguard Europe.

Peter, the chart is showing us yield curves of four major advanced economies. You have the US and UK; the yield curves are low but positive, whereas what stands out is very much Germany and Japan's yield curves. They are negative all the way up to the 10-year maturity. Do you think this is sustainable?

Peter Westaway: Yes, thanks. I think it is a really extraordinary situation. I believe that 30% of the outstanding bonds issued by the advanced economies are in negative territory at the moment. I think it probably is sustainable for the immediate future, because Germany and Japan, at the moment, have set their benchmark – their headline policy rate – at below zero, in negative territory, and they are probably expected to hold them there for the next year or so. So that means as you move out along the yield curve, it will stay negative. Then on top of that, you have QE, which is probably also forcing down some of the yield curve yields, so overall, I think we're going to be having this situation for probably two years, at least.

Biola Babawale: Will it stop people investing in bonds?

Peter Westaway: Well, I know that people are tempted to move their money into cash at the moment, but I think that is probably a little bit risky.

Biola Babawale: But do you think the investor should stick with bonds, even when they are yielding negative interest rates?

Peter Westaway: Yes, I think it is important to remember why you hold bonds in the first place. Bonds are in your portfolio for two main reasons. First of all, they provide stability. They are much less volatile than equities. Second, they act as a diversifier in the sense that when equities go up in value bonds tend to go down and vice versa, so that can be really critical. What this chart shows that if you look at the 25% of worst equity performance outcomes over the last 15 years, what it shows is that on average equities fell by about 6.5%, and over that same period, bonds at different levels of maturity tended to rise in value. On average, the aggregate market for bonds rose by 2.7%, so that is almost a third of the value was recovered by just holding that diversified portfolio in bonds.

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