If rates are negative, why do you expect positive and high returns on your fixed income investments?

If rates are negative, why do you expect positive and high returns on your fixed income investments? For some time now, a strange situation has been hovering in the global economic and financial world. It dates from the end of Great Financial Crisis of 2007-2008. The official conclusion of which was in March 2009. It is no coincidence that the date from which the longest bull market in the history of world markets began. Bull market which, according to some, is continuing even now.

This strange situation is what, with an appropriate acronym, is referred to as ZIRP. That is Zero Interest Rate Policy, i.e. zero interest rate policy. Those involved in finance since then remember well what happened. And who has dealt with it since then studied it. The massive liquidity-providing interventions of the US Fed and the European ECB served a purpose. Injecting liquidity into a system that had suddenly become devoid of it. And do it at rates close to zero, if not exactly at that level. This is because the FED first, and then the ECB itself, together with the Bank of England and the Bank of Japan, had already lowered rates to that threshold.

The gigantic liquidity injection that followed was made to support American and European banks. With zero rates, financing is much cheaper than with higher rates, of course. And this, in classical economics, encourages businesses and people to get into debt. In the first case, to create more jobs and produce more. In the second case to spend more. But if businesses use that money in the right and usual way, sometimes, if not often, people don’t.

If rates are negative, why do you expect positive and high returns on your fixed income investments?

In fact, paradoxical as it may seem, often when people go to ask for loans at the bank, they do not immediately use all the money obtained. One part they spend, and one part they save. But where do they put the rest? Under the mattress, ie on the current account. Leaving it there, to be unproductive. Indeed, to be eaten by inflation. And this is also done by those who invest in fixed income. That is, the “BOT-people”, as the many Italians who invested in government bonds at the end of the last century were called. Why did they do it? Simple. Because in returns they were in double digits. Even close to 20%.

But be careful. Be careful before saying “eh, those were good times … when the state gave you 20% interest on BOTs …”. They weren’t good times at all, far from it. And do you know why? Because inflation was even higher, in those days, than the yield on BOTs. And obviously also BTPs. Which, being of longer duration, also yielded more. That’s right. In the fantastic 1980s and 1990s, inflation in Italy was over 20%. And therefore higher than the yield on government bonds. This means that the real return of the same was negative.

The current situation

Today the same situation arises. In practice, the same thing always happens. The yield on government bonds follows the trend of inflation. And viceversa. But the returns today are laughable, moreover. Zero rates everywhere. BOTs and European equivalents that yield nothing. European BTPs and similar which are negative up to 30 years (as in Germany). And where they are positive, as we do, they yield very little. How much does the Italian decennial make, for example? 1.035%, we tell you. With inflation which, thanks to the recovery, will certainly rise towards the end of the year. And that, before Covid-19, it was at 0.6%.

There is a solution? If you borrow money in ZIRP time, and don’t want to consume them all, it is worth investing the remainder. But not in negative government bonds or with ridiculous yields. If you really are a fixed income aficionado, that’s it corporate is certainly more profitable. With the appropriate attention. Because it is certainly more risky. But, as we all know, more return equates to more risk.

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