We are truly witnessing changes in interest rates that have not been seen before.  Not during the Great Depression, or any recession thereafter, has the world experienced interest yields on sovereign debt this low.  Twelve countries in Europe now have negative yields in the 2-year period on their government bonds, with seven countries having negative yields out to the 5-year period.  Just last week, Sweden cut its interest rates still deeper into negative territory.

The negative-rate phenomenon is giving rise to some strange stories in finance.  The New York Times recently ran a story about a Danish woman who borrowed money from her bank and will actually be paid a tiny amount per month to have the loan.  Germany recently issued five-year bonds with negative interest, meaning that no coupon payments will be made to bondholders, who are assured of getting back less money if they hold the bonds to maturity.

Another unusual discussion is taking place around what could be a seismic shift in the need for physical cash in some of these countries.  Think about it, if you are someday charged negative interest to keep your money on deposit at the bank, would it not be better to hold cash in a safe?  The issue becomes weighing the cost of storage against the cost of negative interest.  In addition, the amount of physical currency in circulation currently may not be enough to handle that kind of demand.

The source of all this are several central banks – including the European Central Bank – which are charging member banks interest to keep money on deposit with them.  The idea is to make it hurt for banks to hoard reserves and instead make a more focused effort to lend money and get the European economy moving again.

Our View: Negative interest rates in Europe will be with us for a while, as the European economy struggles to regain its footing.   Central banks have to be sure the economy has reached escape velocity before bringing rates back above zero.

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