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Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s soundbites, we spoke with Tracy Chen, portfolio manager and head of structured credit at Brandywine Global Investment Management. We talked about whether negative interest rates can be effective at jump-starting a sluggish economy, and we started by asking about the state of household savings.

Tracy Chen (TC): During Covid, people in the higher tier of household income work from home, and their wages are hardly impacted. In the lower income tier, a large share of people lose their job, but there is a massive stimulus from the U.S. government, and their income is even higher than pre-Covid levels. But even if they want to spend, even if they want to travel abroad, or go to the movie theatre, to the hair salon, or to restaurants, they cannot. So, I would say this is a forced savings. As a result, you see a massive increase in household savings. It once got to more than $15 trillion. So, I would say the higher savings rate is harming growth right now but going forward the pent-up demand is huge.

About the attitude of the U.S. federal reserve bank toward negative interest rates.

TC: The Fed already said we are not going to have a negative interest rate. We’re not going to be like Europe. And my argument would be, yes, they are saying that, but the real interest rate is already negative. If you look at the U.S. two-year, five-year, and 10-year government bonds, they already have negative real yields. I think the Fed, they want to have negative real yield to boost the economy. But it doesn’t make sense for us to invest in those bonds. That’s exactly why we have to invest globally.

About how Japan- or European-style negative interest rates might play in North America.

TC: I think negative interest rates are very, very strange animals. To be honest, I don’t think our financial market is set up to accommodate negative interest rates. If you look at the long-term bank stock trend, the Japanese and European bank stocks, they are hammered. They’re not going anywhere. If you notice, the Japanese stock market is doing well. Just not the banking sector. The TOPIX bank index is almost flat since 2009. And the European bank index is actually going much lower, since 2010. If you look at the U.S., the banks are doing much, much better. So, you can see the damage from negative interest rates. The bank’s function in an economy is to transmit the monetary policy to the household and corporations. They are intermediaries. So, if the intermediary is not doing well, I think the monetary transmission system is stuck. This is the first damage. The second damage I see is there are a lot of zombie companies in Europe and Japan. The negative interest rates just shore up their balance sheets. They can still survive even with negative profitability. And that’s not healthy for an economy.

How to find alpha in a low- to negative-interest rate environment.

TC: I think this is a universal question. How can fixed-income investors make money in the negative interest rate world? I think there are three ways. One is to look for the sector which still offers real positive yield, like some emerging market countries, or credit bonds in developed countries, or EM credits. I think those credit story and EM story should do well. But you have to be very selective there. There are still zombie companies in the credit market and there are zombie countries in the emerging market.

What about diversification?

You do need something to diversify from equity investments. And I think the way to do it is to invest in global fixed income, where you can have a large opportunity set. And the other way to go is, if you look at the long-term trend, you compare the S&P [index] versus commodity [prices]. During the last 10 years, the commodity price is severely lagging the S&P prices. If we think inflation is going higher from here, commodity and housing should benefit.

And, finally, what is the lesson here?

TC: I would say be careful what you wish for. Negative interest rates have some damaging effects on banking systems and investors have to go to global fixed income to look for alpha.


Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life.

Our thanks again to Tracy Chen, portfolio manager and head of structured credit at Brandywine Global Investment Management.

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