Tuesday 10 February 2015 by William Arnold Opinion

Australian rates are high by global standards

Interest rates and yields are falling across the world, in some cases to record breaking lows or even negative territory. These falls confirm that a low interest rate environment is well and truly the “new normal”. For this reason, investors relying on cash or term deposit income should consider buying bonds to generate stronger returns, rather than waiting for something to change.

With interest rates at record lows in Australia; generating a good return, especially from term deposit investments, is getting harder.  However, it is much worse in Europe. Several central banks in the Eurozone, as well as Denmark and Switzerland, have cut their interest rates to below zero, in effect investors are paying for the privilege of investing their cash with banks. JP Morgan says that around €220bn of bank reserves are subject to negative interest rates. 

Two weeks ago, Finland became the first country to issue bonds with a negative yield. Its central bank issued €1bn worth of five year bonds paying an interest rate of -0.017%. Investors are paying the government to hold their cash, and they were eager to do so with the issue 1.7 times over bid.

Other government bonds are also trading at negative yields in the secondary market. According to JP Morgan, there is now as much as €1.5 trillion of Eurozone government debt (maturing in more than a year) paying negative yields. For example, Swiss sovereign 10 year bonds have traded at yields as low as -0.322%.

The phenomenon isn’t confined to sovereign debt either. Nestle's euro denominated 2016 notes have traded at around -0.008%; possibly the first corporate bond maturing in more than a year to trade at a negative yield.

The root course of this phenomenon is quantitative easing. Central banks around the world have aggressively been buying bonds, which has pushed prices up and yields down.

While these markets are different to Australia, this is a global phenomenon and the RBA too maintains record low interest rates. Investors who have been sitting on the sidelines in term deposits or cash waiting for something to change may continue waiting for a long time. A long term low interest rate environment appears to be the new normal. Investors may need to adjust their thinking accordingly. Those relying on income from cash or term deposits may want to consider an allocation to bonds to generate a higher return. Depending on the additional risk taken, investment grade bonds can currently offer yields from around 5-6%.

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