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The Edge Markets - Cover Story Investing in The New Abnormal Part 1 - 2016-08-10
The Edge Markets - Cover Story Investing in The New Abnormal Part 1 - 2016-08-10
This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on August 1 - 7, 2016.
IN the past 18 months, the European Central Bank (ECB) as well as the central banks of Japan,
Denmark, Sweden and Switzerland have cut key interest rates to below zero to spur growth. This
unprecedented use of the negative interest rate policy and its growing prevalence are a causing a
rethink in investment and retirement strategies across the globe.
The key objective of this policy is to boost growth, but it does not seem to be working. In Japan, the
loan growth of banks was at its slowest in the last three years in March. Deposits, however,
increased 3% during the month, slightly lower from 3.1% in February.
The most obvious anomaly is how the yen responded to the Bank of Japans (BoJ) January
announcement that it would cut interest rates to negative. Instead of weakening, which would spur
growth, the currency strengthened.
Vasu Menon, vice-president and senior investment strategist at OCBC Singapore, says this
phenomenon occurred because many considered the yen a safe haven amid the uncertainties in
China. Instead of weakening, the yen shot up because the move was smack in the middle of the
crisis in China and the renminbi was weakening. If you have uncertainties around the world, people
just gravitate towards the yen as a safe haven.
Sometimes people regard it as being even safer than the US dollar. In fact, the yen is one of the
best performing currencies in the world. This makes it difficult for Japan to really make the negative
interest rate policy effective.
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If this is prolonged, Teh says it can result in high risk for the entire financial system without adequate
compensation of returns. These negative interest rates can push investors to take on additional risk
due to the lack of yield. At some point, these policies will lose their efficacy and the confidence of
investors.
There is evidence that this already happening. Danny Chang, head of managed investments and
product management at Standard Chartered Bank (M) Bhd, says the lower interest rates are fuelling
carry trade (borrowing at lower interest rates to invest in higher-yielding assets), which leads to
further yield compression.
With US dollar borrowing rates below 1.75% per annum, investors are borrowing in the US dollar
and investing in yielding assets that pay income above this level, such as high-yield and emerging
market bonds.
Yeah paints a starkly darker picture, saying it can result in excessive fear of a market collapse.
There is a certain point in time when the effects kick in, which can result in an excessive fear of
market collapse or worse still, a surge in demand when people suddenly realise that the money is
becoming worthless and start chasing yields as a hedge against inflation.
The potential for asset bubbles becomes very likely. So, the risk is always there for market
disruption, especially when there is so much liquidity in the financial system.
Negative interest rates are not the only issue. Many central banks have reduced their key interest
rates, including Bank Negara Malaysia, which lowered its overnight policy rate (OPR) by 25 basis
points to 3% in mid-July, citing concerns about the Brexit fallout. The move surprised many
economists and industry observers.
Investors will have to brace themselves for such market events, says Yeah. [Negative and] low
interest rate policies are going to create a lot of market swings, so investors will have to brace
themselves for them, whether in bonds or equities. If there is a further cut in interest rates and
quantitative easing, it can build up to a situation that creates an overreaction. Markets tend to have
tipping points, which are really unknown at the moment.
Others do not think a financial crisis will be triggered by negative interest rates alone. While not
discounting the possibility, Affin Hwang Asset Management Bhd chief investment officer David Ng
believes a crisis could be triggered by a convergence of events, such as a surge in inflation.
On the fixed income side, there could be a significant pullback if there is a growth scare. At this
juncture, it looks unlikely. But if for some reason, growth starts to pick up fast, inflationary
expectations start to turn around globally, then you will see yields reverse, he says.
If there is a very certain acceleration in expectations, the equity market in emerging markets could
see a pullback because of a stronger US dollar immediately. But if growth continues, then it should
favour equities and growth assets.
But with so much money ploughing into fewer assets that can deliver satisfactory returns, prices of
assets will continue to inflate, creating the risk of unsustainable bubbles that are set to burst with
serious repercussions. Is there a real risk of this happening?
Menon does not think so. You do have money flowing in the higher yield segment of the bond
markets, but I dont see money rushing in senselessly in a widespread manner.
There has got to be irrational exuberance [before a bubble is created]. We do not have that right
now. In fact, you have a lot of scepticism. If you look at many parts of the world, fund managers are
cashed up and individuals are sitting on a lot of cash and waiting for tactical opportunities before
going in to buy, and then cash out [later].
While you cannot discount the probability of a 10% to 15% pullback, I do not see markets crashing
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