With the BoJ moving to negative policy rates in January, we now have five central banks offering negative rates on reserve deposits, making up more than 20% of the global economy, notes Nomura. Mixo Das and colleagues point out in their July 29 research piece titled “Life at negative rates” that bond yields are negative on almost $12 trillion of government debt, representing over a quarter of the total outstanding debt.

Negative rates don’t imply higher valuations

The Nomura analysts note that during and after the Global Financial Crisis in 2008, several monetary authorities adopted extremely loose policy settings. They point out that the latest in the line of unconventional approaches is the negative interest rates some central banks are offering on reserve deposits. Though central banks charging depositing banks is not a first-of-its-kind practice, with the BoJ moving to negative policy rates in January, discussion of “negative rates” has sharply increased.

Citing Fitch analysis, the Nomura analysts point out that as of June, $11.7 trillion of government debt offers a negative yield, up 12.5% since the end of May, with the bulk of it in Japan:

Negative yields Negative Rates

Das and team at Nomura believe that low/negative rates should impact equity markets. The analysts, however, argue that lower rates don’t mean higher valuations. They note that since early 2014, valuations have not fallen alongside the decline in yields, implying that equity markets are not expecting rates to persist at low levels. The analysts anticipate downside risks to equity valuations if bond yields persist around current levels.

The Nomura analysts reason that three factors drive overall equity prices: expectations about earnings / dividend growth, risk-free rates, and market risk perception. They believe it’s important to focus on longer term bond yields and that policy settings don’t exist in isolation. The Nomura analysts point out that in the current environment, yield curve slopes have flattened and inflation expectations and bond term premia have dropped.

Drop in premia

Asian and EM equities are relatively more attractive

Das and colleagues note that while the rising risks and lower growth expectations offset the benefits of lower risk-free rates in the affected markets, the impacts vary as one moves further away. They believe markets in which the transmission of lower rates is stronger than the transmission of lower growth stand to benefit in relative terms.

The Nomura analysts highlight that considering the spread of negative rates in Europe and Japan, one should anticipate outflows from both regions into higher yielding and higher growth assets. For instance, bond and equity portfolio outflows from Japan have picked up to their strongest levels on record. Similarly, portfolio outflows from Europe turned into positive territory on a 12-month rolling basis after the ECB’s move to negative rates in 2014 and have been rising:

 

Das and team believe that even though the absolute direction of global equities in the medium term is not clear, there will be rising cross-border flows from jurisdictions affected by negative interest rates. The analysts prefer markets in which the transmission of lower rates is stronger than the transmission of lower growth from DMs. They believe the stocks in Asia that will benefit most are those that exhibit some combination of high and sustainable yield or the ability to pay more.