·Lower bond yields. By taking overnight borrowing rates into negative territory, central banks have pushed short-term bond yields into negative territory, forcing investors to extend maturity to obtain higher yields. In response, intermediate- and long-term bond yields have also declined, leading to “flatter” yield curves [Figure 2]. Although this may penalize savers, it is a desired result from a central bank perspective as its lowers the cost of borrowing for many. More than $7 trillion worth of government bonds trade with negative yields, out of a global bond market of nearly $100 trillion.[1]

· A stronger U.S. dollar. Short-term interest rate differentials are a key driver of currency valuations. By lowering benchmark interest rates into negative territory, the U.S. dollar strengthened against major currencies such as the euro and yen from mid-2014 through the end of 2015. The U.S. dollar weakened slightly during the first quarter of 2016, but it remains elevated versus major currencies and has created economic challenges not only for U.S. manufacturing but also for international economies.

· Increased demand for U.S. bonds. Negative interest rates in Europe, coupled with the ECB’s decision to further cut interest rates in March 2016 have been one factor behind outflows from European bond mutual funds, according to Investment Company Institute data. Assets under management in international bond funds have witnessed an approximate 30% decline since the start of the year through the end of March 2016. U.S. core bonds, on the other hand, have witnessed a 25% gain in assets—and this does not include other U.S. bond categories such as municipal, investment-grade corporate, and high-yield dedicated bond funds that have also witnessed respectable gains in assets so far in 2016. Strong demand for U.S. bonds has helped keep U.S. interest rates low despite prospects for Fed rate hikes in 2016 and beyond.

Concerns over global economic growth also played a role in the factors above, but these drivers are all intertwined.


RISKS

The above consequences are also partly in response to some of the risks associated with negative interest rates, including:

· Bank risks. Banks function as the grease that lubricates the wheels of the global economy. Negative interest rates can harm a bank’s profits and potentially impair its creditworthiness. Bank funding fears, although calm now, contributed to stock market weakness and Treasury strength in early 2016.

· A bleak outlook. Negative interest rates reflect weak economic growth and a potentially deflationary environment in the host country. Therefore, negative interest rates imply a poor investment outlook and may hinder investment necessary to engineer improvement in the local economy.

CONCLUSION

Based on a limited history, negative interest rate policies have yet to show any meaningful positive impact, and at the same time have created unintended consequences and risks from global financial markets. Thankfully, Fed Chair Janet Yellen has pushed back on the idea of negative rates in the U.S. In her press conference following the March 2016 Fed policy meeting, Yellen stated negative rates are not being considered and labeled the experience in other countries as “mixed” with both positive and negative impacts.

This week’s Fed policy meeting will not include a press conference or economic projections, only the brief policy statement, and is unlikely to be a market mover. (See our recent Weekly Economic Commentary for more on this week’s Fed meeting.) The BOJ also meets this week but is not expected to cut rates; however, according to Bloomberg consensus, additional stimulus, which could involve another rate cut, is expected by the end of June 2016. The persistence of negative rates around the globe may keep demand for U.S. bonds elevated, limit any potential rise in interest rates, and keep bonds expensive for investors.

Anthony Valeri is fixed-income and investment strategist for LPL Financial.

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