In 2006, while the Federal Funds rate sat at near 5%, the notion of negative interest rates hitting the U.S. seemed absurd.
Fast-forward to today and the thought of rates turning negative isn’t so far-fetched. As the world reacted to the slow growth following the 2008 recession by pushing down rates in an effort to encourage banks to lend and people to spend, many countries, including Japan and Switzerland, have experienced negative rates for some time. The 10-year government bond yields within 11 countries trade below zero, according to Cammack Retirement Group. Meanwhile, President Donald Trump has called for U.S. interest rates to drop to zero.
Much of this has occurred during a time of economic recovery. If a global recession does hit next year, as some expect, then that puts more pressure on the Fed to encourage spending. The possibility of rates eventually turning negative no longer seems outrageous.
In a negative interest rate environment, much of the assumptions we have about finance, disappear.
With the notion of negative rates being such a new economic phenomenon, the question of who would bear the brunt of their downside remains.
It would likely “act as a tax on savers,” says Tracy Manzi, VP of investment services at Cammack. While she says it’s still a very low likelihood they could hit the U.S., she does think savers will suffer the most if they do.
There are few better savers out there than those trying to super-save their way to early retirement. Yet, whether you’re looking to retire in your 30s or seeking a more traditional retirement age, if negative interest rates were to hit, then it would signal the need to save more as well as spend less, since your portfolio won’t grow – without taking on more risk – as much as you need it after you step away from the job.
High Yield Savings Accounts Will Tighten
High yield savings accounts are important for anyone pursing early retirement, but also valuable tools for anyone in retirement, since you can store a year or two worth of expenses in the account and earn 1.5%, or a little more, back. It’s far better than putting money in your proverbial couch cushion, since it’s about as safe but also earns some return.
But in a negative interest rate world, expect these high interest savings accounts and certificate of deposits (CD) to see the percentages they offer to fall even further than they have over the past 20 years.
Reuters found that since the Fed began lowering rates ahead of the 2008 Recession, only recently had interest rates begun to climb above levels that allowed CDs to grow faster than inflation. CDs tend to earn higher rates than high yield savings accounts. Since the recent rate declines, however, CDs rate of returns are nearly in line with inflation. This could further depress if rates march steadily downward.
Savings Accounts Are Likely Safe For Now
Much of the pricing within financial services assumes a positive interest rate. If that reverses, it could upend some normal banking practices. Would you have to suddenly start paying the bank interest to store money in your savings account, for instance?
Not likely, says Manzi. The negative interest rates would be meant to encourage the banks to spend the money that’s sitting in their vaults. They, however, wouldn’t want to necessarily charge customers the same amount, since it would encourage users to take the money out of the bank. Since banks would want to prevent deposit flight, it wouldn’t likely start charging interest. That’s the case if you assume the negative rates don’t last long.
That’s what we’ve seen so far in Switzerland, according to JP Morgan. Instead, banks have lowered the savings account deposit rate to nearly zero. Meanwhile, they’ve slowly charged commercial customers, since businesses need a place to store cash.
If, however, the negative rate environment lasts too long or reach even lower depths, “the benefits no longer outweigh the shortcomings” of charging regular savings accounts, wrote JP Morgan Asset Management strategists Hugh Gimber and Jai Malhi.
Risk Aversion Will Be Discouraged
There are three components to securing retirement. You can save more, spend less or take on more risk. A negative interest rate environment impacts all three of those buckets.
For example, JP Morgan also found that for a European investor with a 50% bond and 50% equity portfolio, 100% of the returns come from the equities in the portfolio.
In a negative interest rate environment, bonds won’t look appealing, especially the longer the negative interest rates remain. It will force investors that seek bond security, into riskier, more volatile assets, like high-yield corporate bonds.
“That makes risky investments preferable, even if they promise historically low prospective returns,” wrote OakTree Capital Management’s director Howard Marks in describing the impact negative rates would have on traditional investing practices, if they become the norm. “In this way, risk aversion is discouraged.”
Therefore, you’ll also need to save more, since it’s going to be more difficult to “generate a lot of income from the money you’re saving,” added Manzi.
For those already in retirement, it’s likely a good time to ensure your cash reserves have been restocked. Since stocks fall 30%, on average, during a bull market, a portfolio with a 60% equity, 40% bond mix wouldn’t have many triggers in place for safety if the weak market also forces interest rates to surpass the zero barrier.
In such a scenario, cash in the cushion – or a savings account – beats having to withdraw from the portfolio.