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Weekly Market Digest: What Are Negative Interest Rates?

A relatively range bound and choppy week for the US stock market ended with a busy news day on Friday and ultimately a steep decline in equity markets as US/China trade developments continued to worsen.

China announced additional retaliatory tariffs on about $75 billion of US goods to go into effect on September 1st and December 15th, right as US tariffs on Chinese goods are set to begin. The new tariffs out of China are primarily directed at automobiles, oil, and soybeans among other products.

Also, in a highly anticipated speech on Friday, Federal Reserve Chairman Jerome Powell assured the Fed would cut rates again soon, though he did not get into specifics on the size of a potential cut. US stock market indices did temporarily climb higher for the day after the Chairman’s speech, but quickly reversed once President Trump took aim at China and the Fed Chairman on Twitter.

Weekly Returns

S&P 500: 2,847 (-1.45%)
FTSE All-World ex-US (VEU): (-0.62%)
US 10 Year Treasury Yield: 1.54 (-0.01)
Gold: $1,527 (+0.86%)
EUR/USD: $1.1144 (0.49%)

Major Events

  • Monday – The Trump Administration, in an attempt to avoid overly disrupting customers of China’s Huawei Technologies, agreed to let some US companies continue to do business with the Chinese telecommunications giant.
  • Monday – US housing starts dropped for third month in a row, largely due to weakness in multi-family home starts. Single family home starts increased 1.3% in July.
  • Tuesday – After a three day winning streak, the Dow Jones Industrial Average fell 173 points, or 0.7% as investors waited for more clarity on rates and trade.
  • Thursday – Despite looming recession concerns, initial jobless claims (folks filing for unemployment benefits) fell more than was expected.
  • Friday – China announced additional tariffs on about $75 billion of US goods to go into effect on September 1st and December 15th in response to US imposed tariffs on China set to begin on the same dates.
  • Friday – Federal Reserve Chairman Jerome Powell delivered a speech in Jackson Hole, Wyoming where he described the limits of monetary policy when it came to countering the effects of an escalating trade war between the US and China.
  • Friday – The Dow Jones Industrial Average fell 2.37%.

What Are Negative Interest Rates?

By now you may be well-informed on modern issues such as Brexit, the U.S./China trade conflict, and a flat, sometimes negative, yield curve, but what about this other development you’ve heard mention of recently – negative interest rates? What does that even mean?

When you deposit money with a bank, you’d be right to expect that bank to periodically deposit additional funds in your account in the form of interest. Similarly, when you purchase a bond (i.e. lend money to the issuer of the bond), you’d be right to expect that after maturity of that bond you will have walked away with more money than you started with.

Well, what if instead of the bank paying you interest to hold your cash, you paid the bank? What if you bought a bond that promised to pay you back less than you originally invested?

Doesn’t sound very practical, does it? Well that’s exactly what’s taking place overseas in many developed countries such as Germany, France, and Japan.

Essentially when central banks implement a negative interest rate policy, they are pushing banks to lend money, as opposed to hanging on to funds. This is often done in deflationary environments (falling prices for goods and services). The incentives created should, in theory, encourage more people to spend, and investors to invest, resulting in economic growth.

However, this unusual tool of monetary policy does have many economists concerned, as the long term implications of such an approach are quite uncertain.

These are mostly uncharted waters and it’s too early to tell if negative interest rate policies will ultimately help or hurt economies overseas. We recommend investors avoid trying to bet on the result.

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