IS the world turning upside down or is it real? Early this month, Denmark’s third largest bank, Jyske Bank, set the lending rate for mortgages at an unbelievable interest rate of -0.5%.
Yes, no typo here. It is NEGATIVE 0.5%. Another bank in Denmark also set a new precedent. Nordea Bank, is now giving 30-year home financing at 0.5% while 20-year loan at zero rate. That’s right, ZERO.
With the low yield environment today, lending rates are now being pushed lower and lower as deposit rates too are under water. In certain parts of the world today, we are now punished for savings as we would need to pay the bank to keep our fixed deposits or savings while the bank at the same time is virtually giving out money for free, or in some cases, the bank is paying you to take a loan!
Well, not really! In effect, what the bank does is that while borrowers service their monthly instalments, the amount that is reduced from your outstanding loan is more than what you pay. In the traditional concept, when interest rates are normal, the certain portion of that monthly payment goes towards loan servicing and the balance to reduce the principal sum.
How does a bank function profitably in this low yield environment? It is still a net interest margin (NIM) game as a bank would still need to ensure that its NIM remains positive. Banks too may have hidden charges in the form of various fees to boost its non-interest income. In essence, while these banks in Europe today are charging negative rates for lending or near zero, their deposit rates would indeed be a deeper negative rate. In Denmark, the central bank’s benchmark rate is at negative 0.65% while two to 10 years sovereign papers are effectively trading at yield to maturity of between -0.80% and -0.59% respectively. What this means is that even the banks are able to fund their balance sheet by getting paid when the borrow from the inter-bank market while money market rates too are deeply negative.
As the world’s bond markets continue to rally, pushing yields lower and deeper into negative territory, we are indeed living in a complex world today. Century bonds or 100-year sovereign papers are increasingly being sought after as investors rush to have some pick-up in yield in an environment where even a 1% or 2% yield is considered value for money and attractive for savers, especially in Europe. Greece had launched a century bond in 2017 and maturing 100 years later, i.e. in 2117 (I am sure most of us will be dead by then) at a yield of 2.1%, and sold the same papers again just in June this year at a bid-to-cover ratio of more than 4x and at a yield of 1.17% for the remaining 98 years tenure.
A 100-year fixed income paper at a very low yield is a high risk game as one basis point change in yield results in a significant move in price. Today, that 100-year bond is trading at price of about 200 euro cents and what a scary thought to think that by the time it matures, this bond will mature at 100 euro cents – half the price! The rally in this Austrian century bonds is nothing but spectacular, giving its original investors two years ago more than 50% capital gain on an annualised basis while investors who bought the secondary placement just two months ago are now sitting on a 30% capital gain.
The onslaught of cheap funding is accelerating. Germany launched a 30-year zero coupon sovereign paper this week at -0.11%, while the US too is now mulling the idea of launching ultra-long dated papers of beyond the traditional 30-year long bond, with 50-year or even the century bond. This is on the premise that rates are low enough and investors are hungry for duration on the expectations that rates can go even lower. As it is the 30-year US treasuries too recently fell below 2%, an all time low. But not all investors are buying into this ice-age investing phenomena as the German 30-year auction only received lukewarm demand from investors.
What does all this mean for Malaysia? The global low yield environment has indeed made debt, a cheap source of funding. The Malaysian benchmark 10-year MGS was last seen at about the 3.36% level – which is very attractive by global standards today and still well above its historical low of 2.87%, which was observed some 10 years ago.
With the outcome of FTSE World Global Bond Index (WGBI) decision to maintain or to drop Malaysia’s status in the index remains, the undervalued nature of Malaysia’s bond papers will likely see little impact on investors’ sentiment, other than a knee-jerk reaction should Malaysia be removed from the widely followed bond benchmark index.
With the world moving towards lower benchmark rates, central banks too have moved in tandem with what the market is pricing at, Malaysia has indeed room to lower rates even more.
With benign inflationary pressure, disruption to our external demand as well as slowing public investments and to ensure public consumption is sustained, a lower interest rate could ignite the economy even more as most economist expect the second half of 2019 or even 2020 to be tougher than the 4.7% GDP growth achieved in the first half of this year.
Malaysia may not experience sub-zero rates that may allow us to fund our big ticket items using other people’s money, but the lower benchmark rates, which will lead to lower lending rates, can be a boon to the economy as well as consumption. Malaysia’s attractive yield pick-up, whether in the financial markets through debt papers or equities could also spill over to the real economy, especially towards income yielding assets, like the property market. This will indeed be good for Malaysia.
While the rest of the world see debt as cash equivalent due to the sub-zero interest rate environment, Malaysia’s positive yield carry should be a magnet to investors. Importantly, we must make efforts to attract these portfolio investors into Malaysia.
For foreign direct investors, raising capital in their home country based on attractive funding cost, coming to Malaysia is almost a no-brainer as Malaysia has the right infrastructure for any large multi-national company to be based here. Indeed, we are observing a very different world of finance today where debt is now like cash or cash equivalent and cash can be a liability, at least as far as in countries where interest rates are at sub-zero level.
The views expressed here are solely that of the writer.