The March 2015 Global Financial Centres Index (GFCI) has been produced by Z/Yen and has placed New York in the number one spot for the second consecutive year, closely followed by London. The cities are scored on a number of factors including: business environment, financial sector development, infrastructure, human capital and reputational and general factors.
The four leaders, New York, London, Hong Kong and Singapore retain their relative ranks with Tokyo following 32 points behind. Closing in on the traditional western competitors are Asian cities. Eleven out of the top twelve Asia/Pacific centres were up in their ratings and rankings. Busan in South Korea had the largest rise, followed by Shenzhen in China and Taipei in Taiwan. The Chinese centres all rose with Dalian entering as a new entrant in 51st place.
Singapore, up eight points, remained in fourth place followed by Tokyo, Zurich and Seoul. All three cities moved up a place in the rankings following San Francisco dropping points as the lustre comes off its fintech status.
“The average rating of the top five centres in each region shows that the historical dominance of the leading centres in Western Europe and North America has eroded over time and is now lower than the mean of the top five centres in the Asia/Pacific region.”
Australia has not ranked in the top 10, but Sydney, seen as dynamic, is up two places to 21, making gains in business environment and infrastructure, and Melbourne, also considered dynamic, has dropped four places to 28. In addition, though Sydney and Melbourne are both established centres, Sydney is also considered to be transnational, that is that more than 55% of the ratings were provided by other centres.
Global banks setting negative interest rates on deposits and bonds trading with negative yields is a first for most investors, but what does this phenomenon actually mean? Many investors would assume that an interest rate or bond yield could not drop below zero, however, with institutions such as the European Central Bank (ECB) setting a deposit rate for commercial banks of -0.2% in December 2014, Denmark’s central bank re-setting a deposit rate of -0.75% following its initial negative rate cut in July 2012 and as of February 2015, Sweden’s central bank reducing its main interest rate to -0.10%, we have had to rethink our understanding of rates.
European government bond yields are also trading in negative territory, with maturities of five years or less now yielding negatively. This means that a bond holder that keeps their bond until maturity will get back less capital and coupons than they spent to buy them.
Yale’s Sterling Professor of Economics, Robert Shiller, believes that a bond bubble has grown in the developed world as a consequence of low bond yields and high prices (being that they move inversely).
So how have these negative interest rates and bond yields come about? One might argue that nominal negative yields are not important, that in fact real rates have been negative for a number of years now. But we need to understand why they are negative and what the implications are for us as investors.
In Europe economic performance, central bank decisions and technical factors are all contributing to the downward pressure. For bond yields these could be further expanded to low growth, low inflation, weak demand and high levels of debt. This is the opposite to the US, where due to the deleveraging of households the debt-to-income ratio is back to its 2003 level.
Unlike Europe where austerity was used to sustain government spending and retain deficit, the US kept borrowing creating massive budget deficits through the global financial crisis, but promoting economic activity allowing households to repair finances.
So the levels of private or household debt may have reduced in absolute terms, there was an even greater decline in economic output which meant that countries with this imbalance were left with a high debt burden. To keep those debt burdens sustainable it is key that there are very low borrowing rates.
In addition to help those effected economies grow faster it is essential that commercial banks lend money to the households or private economy, as such, negative central bank deposit rates are part of this effort.
There is some irony in the European Central Bank’s official response to generate growth. Their decision to buy €1.1 trillion of mostly government bonds over the next 18 months has increased their prices by generating more demand, this in turn forcing yields ever lower. This has the knock-on consequence of decreasing the exchange rate of the euro against other major currencies such as the pound or the US dollar – this in theory helping eurozone exporters to be more price competitive.
Technical and regulatory factors are also meaning investors will carry on buying government bonds even with the negative yields. The capital and liquidity buffers that banks now have to maintain mean that they have demand for cash or high-quality short dated bonds. This weight of money matches liabilities at the short end of the yield curve. Banks are also using the short dated government bonds as collateral for their derivative exposures. In summary, the banks are not holding these types of government bonds as profitable investments, but more because they have to in order that they meet their regulatory requirements.
And for the average investor the take-away from the current situation may mean that we enter a cycle of low returns in all of our assets in future. The days of high interest rates are long gone, at least for now. If the risk-free government bonds are low, then there is nothing to stop the negative values pouring downward rapidly into other asset classes.
The good news is that thus far we have not been exposed to the negative rate environment experienced in Europe or the US. Never say never, but unless you wish to invest in global government bonds, you won’t have to navigate past some of these negative yielding exposures.
It would seem that there is no way to take advantage of this cycle unless you’re a major institution that needs to buy short term bonds for reasons other than return. And to that extent, you may be correct in thinking so, but with investments like credit funds that link directly to the rates set to individual borrowers, and by using careful borrower assessment to reduce risk, or letting a third party fund manager do this for you, one would be able to achieve far greater positive returns than those in short term bond yields or bank interest earning accounts and still keep risk exposure to a minimum.
The alternative it to stick with well sourced global equities managers – actively managed best of breed. If rates remain low for a long period, which all indications suggest they will, then equities allocations will continue to increase, and with that, yield and returns will be found in well managed global equities funds.