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Zero interest rates: what UK investors can learn from Japan



The glossy Tokyo branches of Japan’s big trust banks offer a startling menagerie of investment options. You can open deposits in sterling, dollars and euros. There are investment trusts themed on sustainability, fintech and driverless cars.

For the properly adventurous there is a fund that invests in Turkish bonds, which offers a tempting interest rate and a five-year return history of minus 54 per cent.

What is almost completely absent is any suggestion that the customers might want to deposit money in yen. The interest rates on offer, which a determined customer can track down via the web, suggest why: for a term deposit of any size, over any period of up to five years, with a fixed or a floating interest rate, the banks will pay 0.002 per cent. Deposit enough money to buy a house and the annual interest should be enough for a cup of coffee.

While low or negative interest rates are still relatively new in the UK and Europe, Japanese savers have been wrestling with the phenomenon for more than two decades, since rates first hit zero in 1999.

In that time, they have experimented with all sorts of investments, and while they have found few good answers, they have learned a number of bitter lessons about what does not work — lessons that may now be relevant to their British counterparts. When the best available savings rates are around 1 per cent for a two-year fixed deposit, it is really time to consider seriously the Japanese experience.

“When interest rates are low is when you really need to invest carefully or you will lose your capital,” says Taichi Matsuda, who instructs financial advisers at Mitsubishi UFJ Trust, one of Japan’s largest investment managers. Those lessons include the potential for decades of low interest rates, the seductive lure of higher rates overseas and the need to take on and manage risk actively rather than pining for a past era of safe returns.

The simplest lesson — that low interest rates are here to stay — is one that took many years to sink in. When Japanese interest rates first hit zero in 1999, it was regarded as an oddity, trapped by unique circumstances. The world economy was in good shape and working itself towards the peak of the internet bubble. Many investors expected that Japanese rates would rise back to the levels of other developed nations and its large public debt would cause a crisis.

Rather than a debt crisis, however, Japan showed that low interest rates can go still lower. The nation’s ageing demographics — which are shared to a lesser degree by most advanced economies — meant a growing multitude of elderly savers, with 29 per cent of Japanese aged 65 and over.

Meanwhile, Japanese corporations that once gorged on bank credit, have lost the drive of their heyday in the 1970s and 1980s; they are reluctant to borrow and invest in a declining domestic market. No matter how low rates go, saving and borrowing have struggled to find an equilibrium.

In the mid-2000s, when Japanese 10-year bond yields hovered around 1.5 per cent, some strategists said they could not go lower and urged investors to sell bonds. But the trade of shorting Japanese government bonds in anticipation of a debt crisis became known as the “widow-maker” for its harvest of investment victims. Today, the Bank of Japan now targets a 10-year bond yield of around zero, while 30-year bonds yield just 0.65 per cent.

During the Covid-19 crisis, US and UK government yields have fallen close to those levels. Though British savers can still make some kind of a return on term deposits, Japan suggests a return to positive overnight rates may be a long time in coming.

“One thing you can say for sure is that low rates have become long-term,” says Takashi Abe, the chief executive of Ales Investment Advisors, a firm of financial advisers based in Tokyo. “Even massive quantitative easing hasn’t generated inflation.”

The rise of the yen carry trade

Because Japan was the first country to reach ultra-low interest rates, and it was so unusual at the time, there was an obvious temptation for Japanese investors. While their own interest rates were zero, US interest rates peaked at 6.5 per cent in the summer of 2000. By holding their savings in a different currency, a yen-based investor could earn vastly more interest.

That led to the early 2000s heyday of the yen carry trade and “Mrs Watanabe”, the archetypal Japanese housewife-turned currency investor. Most high street banks in Japan began to offer foreign currency deposits, with displays in their windows showing interest rates in dollars, euros, Swiss francs, sterling and other currencies. “Japanese investors targeted high interest rate currencies such as the Australian or New Zealand dollar,” says Yoshihiko Kobayashi, president of the retail currency brokerage JFX.

The constant selling of yen by retail investors, as well as hedge funds, helped to keep the currency weak and for a time the currency investment strategy did well. For example, a Japanese investor who deposited their cash in sterling in 2000 not only enjoyed British interest rates of 4 or 5 per cent a year, but a decline in the yen from around ¥150 to ¥250 against the pound between the summer of 2000 and 2007, giving them a double-digit return. That was vastly better than the zero they would have earned from yen deposits — until it all went wrong.

In the wake of the global financial crisis and the collapse of Lehman Brothers, the yen soared above ¥80 to the dollar and reached a peak of ¥120 against the pound, wiping out years of accumulated interest for those who got in early or imposing capital losses on those investors who entered the market late. “The outcome depended on their entry level,” says Mr Kobayashi. “Buy-and-hold in a high interest rate country is extremely risky.”

Japan’s largest banks still offer deposits in the main G7 currencies, but they now have zero interest rates too. Some smaller banks have moved on to a wider range of currencies: for example, Daiwa Next Bank, a banking arm of the Daiwa Securities group, is advertising interest of 1 per cent in South African rand, 1.5 per cent in Turkish lira, 1 per cent in Mexican pesos or 0.2 per cent in Chinese renminbi.

At some point, British banks may try the same ploy of luring customers with temptingly high interest rates in a foreign currency, but Japan’s experience — as well as standard economic theory — suggests they involve a lot of risk for dubious returns. High interest rates often reflect high inflation and a falling exchange rate.

“The yen is stable at the moment. There’s no volatility in currencies or bonds,” says Mr Abe. “People who trade currencies have moved towards the domestic stock market.”

Real estate woes

In Britain, the most popular asset is property, with low interest rates accompanied by a dramatic rise in house prices. Japanese real estate has shown strikingly different behaviour, however. After rising fivefold or more during the 1980s bubble, property prices slumped during the 1990s, and even after interest rates hit zero in 1999 there were only modest rises in real estate prices or investment.

Several factors help explain why Japanese property prices have behaved this way. Japan’s population is declining and shifting to Tokyo, which has meant reduced demand and high vacancy rates in many regional cities, holding down prices. Structures in Japan tend to be knocked down and rebuilt every 40 or 50 years, so investors need to reckon with a high rate of depreciation.

Perhaps most importantly, new construction is relatively easy in Japan — including in Tokyo — so property does not have the extreme scarcity value that it does in London, Paris or Hong Kong. Huge apartment building on reclaimed land around Tokyo Bay is a case in point.

Several areas of the property market have prospered: expensive apartments on the high floors of Tokyo tower blocks have done particularly well thanks to a quirk in inheritance tax law.

Various schemes have sought to lure private investors into the property market. One notable scandal involved loans to buy “shared houses” with communal facilities, aimed at single, low-income women moving to work in Tokyo and other big cities — the supply soon vastly exceeded demand and the investors lost money.

How the UK and Japan compare


Total population: 66.8m

Population aged 65 and over: 19%

Population growth rate: 0.6%

GDP average growth rate (2009-2019): 1.87%

Forecast GDP growth rate 2020: -5.27% GDP per head: $44,287

Household savings as a percentage of disposable income: 0.74%

Currency/deposits as percentage of household financial assets: 25.1%

Household debt as percentage of net disposable income: 142%

Source: IMF, World Bank, OECD


Total population: 126.3m

Population aged 65 and over: 28%

Population growth rate: -0.2%

GDP average growth rate (2009-2019): 1.27%

Forecast GDP growth rate 2020: -9.76%GDP per head: $41,636

Household savings as a percentage of disposable income: 4.29%*

Currency/deposits as percentage of household financial assets: 52.8%**

Household debt as percentage of net disposable income: 107%***

*2016 data; **2017 data; ***2018 data

But on the whole, Japanese investors have not turned to property as a place to park their money in the low interest rate environment. The investment market for apartments is growing but constrained by a lack of credit, says Keiichi Kurauchi, president of the brokerage website Kenbiya. “Japan has lots of wooden structures and it’s hard to borrow on them,” he says. Without easy access to leverage, or the lure of big capital gains, property has not become a retail investor obsession.

Such differences in market structure help to explain why British investors have had a different experience. But Japan also shows that low interest rates do not guarantee eternally rising house prices. Much depends on population growth in the UK and whether British planners permit new houses or force residents to compete for the existing stock.

That leaves the options for Japanese investors narrowing down to one simple choice: put their money to work in the stock market or leave it in the bank. Historically, Japanese savers have been wedded to bank deposits, and the experience of the 1980s bubble and the devastating 1990 stock market crash, when the Nikkei index ultimately fell by more than 80 per cent from its all-time peak, reinforced that conservatism. But the past 30 years have been one long campaign to force a rethink.

On the one hand, Japan’s long years of ultra-low interest rates damped any desire to take risk. Pervasive gloom about the future and the stagnation of Japan’s stock market throughout the 2000s led many to conclude that while the bank might pay zero interest, the stock market was not much better — and risky to boot.

This year’s economic downturn has had a similar effect on risk appetite. “Japan has had a long experience with low interest rates so the coronavirus environment isn’t really new for people,” says Mr Abe. “It’s more that the shock puts them off investing at all.”

In a world with low returns, as well as growing job insecurity and uncertainty about the future of public pensions, potential savers wanted to hold on to what they have rather than take risks in pursuit of high returns. “Many of our customers are older and rather than aggressive investments they want to preserve their capital,” says Mr Matsuda.

But in recent years there has been a gradual change in attitude. Shinzo Abe, the prime minister from 2012-2020, made a determined effort to increase investment in stocks. One part of that was a new governance and stewardship code, aimed at making Japanese companies more shareholder friendly, and increasing their return on capital.

FT series: Lessons from Japan

The Abe administration also changed the investment portfolio of the Government Pension Investment Fund, the world’s biggest pension fund, with ¥167.5tn ($1.6tn) in assets under management. A large part of its holdings in Japanese government bonds was switched into domestic stocks, foreign bonds and foreign equities. That set a clear benchmark for other Japanese savers to follow.

“If we have a study group or a seminar then I notice that participation from a younger age group has really increased,” says Takashi Abe. “They are more concerned about the future and feel like they have to invest. People realise that their bank deposits aren’t going to increase.”

Throughout the 2000s and 2010s, the Japanese stock market relied on inflows from foreign investors for much of its activity, but in the past 18 months that has begun to change. The Nikkei 225 has reached levels not seen for almost three decades, with the activity driven by local investors. Even at around 26,800, as it was this week, it still is well short of its 1989 record of 38,916.

Compared with the strength of the US market, Japan looks a bit cheaper, according to strategists, especially given a much greater latent potential for companies to restructure and increase their returns. Japanese equities now trade on a forward price/earnings ratio of 20.5, versus 21.8 for the US. Depressed by Brexit uncertainty, the UK market is on a lowly 14.9.

Mr Abe advises his clients to assemble a portfolio of Japanese equities. “There’s no escape from low interest rates. In that case, the only thing you can do is invest in stocks,” he says. “Taking a risk on stocks is less risky than not investing.”

With interest rates now low across the developed world, British investors may come to the same conclusion.

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European markets recover after tech stock fall




European equities rebounded from falls in the previous session, when fears of a US interest rate rise sent shares tumbling in a broad decline led by technology stocks.

The Stoxx 600 index gained 1.3 per cent in early dealings, almost erasing losses incurred on Tuesday. The UK’s FTSE 100 gained 1 per cent.

Treasury secretary Janet Yellen said at an event on Tuesday that rock-bottom US interest rates might have to rise to stop the rapidly recovering economy overheating, causing markets to fall.

Yellen then clarified her remarks later in the day, saying she did not think there was “going to be an inflationary problem” and that she appreciated the independence of the US central bank.

Investors had also banked gains from technology shares on Tuesday, after a strong run of quarterly results from the sector underscored how it had benefited from coronavirus lockdowns. Apple fell by 3.5 per cent, the most since January, losing another 0.2 per cent in after-hours trading.

Didier Rabattu, head of equities at Lombard Odier, said that while investors were cooling on the tech sector, a rebound in global growth at the same time as the cost of capital remained ultra-low would continue to support stock markets in general.

“I’m seeing a healthy correction [in tech] and people taking their profits,” he said. “Investors want to be much more exposed to reflation and the reopening trades, so they are getting out of lockdown stocks and into companies that benefit from normal life resuming.”

Basic materials and energy businesses were the best performers on the Stoxx on Tuesday morning, while investors continued to sell out of pandemic winners such as online food providers Delivery Hero and HelloFresh.

Futures markets signalled technology shares were unlikely to recover when New York trading begins on Wednesday. Contracts that bet on the direction of the top 100 stocks on the technology and growth-focused Nasdaq Composite added 0.2 per cent.

Those on the broader S&P 500 index, which also has a large concentration of tech shares, gained 0.3 per cent.

Franziska Palmas, of Capital Economics, argued that European stock markets would probably do better than the US counterparts this year as eurozone governments expand their vaccination drives.

“While a lot of good news on the economy appears to be already discounted in the US, we suspect this may not be the case in the eurozone,” she said.

Brent crude, the international oil benchmark, was on course for its third day of gains, adding 0.7 per cent to $69.34 a barrel.

Despite surging coronavirus infections in India, the world’s third-largest oil importer, “oil prices have moved higher on growing vaccination numbers in developed markets”, said Bank of America commodity strategist Francisco Blanch.

Government debt markets were subdued on Wednesday morning as investors weighed up Yellen’s comments with a pledge last week by Federal Reserve chair Jay Powell that the central bank was a long way from withdrawing its support for financial markets.

The yield on the 10-year US Treasury bond, which moves inversely to its price, added 0.01 of a percentage point to 1.605 per cent.

The dollar, as measured against a basket of trading partners’ currencies, gained 0.2 per cent to its strongest in almost a month.

The euro lost 0.2 per cent against the dollar to purchase $1.199.

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Yellen says rates may have to rise to prevent ‘overheating’




US Treasury secretary Janet Yellen warned on Tuesday that interest rates may need to rise to keep the US economy from overheating, comments that exacerbated a sell-off in technology stocks.

The former Federal Reserve chair made the remarks in the context of the Biden administration’s plans for $4tn of infrastructure and welfare spending, on top of several rounds of economic stimulus because of the pandemic.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said at an event hosted by The Atlantic magazine.

“So it could cause some very modest increases in interest rates to get that reallocation. But these are investments our economy needs to be competitive and to be productive.”

Investors and economists have been hotly debating whether the trillions of dollars of extra federal spending, combined with the rapid vaccination rollout, will cause a jolt of inflation. The debate comes as stimulus cheques sent to consumers contribute to a market rally that has lifted equities to record levels.

Jay Powell, the Fed chair, has said that he believes inflation will only be “transitory”; the central bank has promised to stick firmly to an ultra-loose monetary policy until substantially more progress has been made in the economic recovery.

The possibility of interest rates rising has been a risk flagged by many investors since Joe Biden’s US presidential victory, even as markets have continued to rally.

Yellen’s comments added extra pressure to shares of high-growth companies, whose future earnings look relatively less valuable when rates are higher and which had already fallen sharply early in Tuesday’s trading session. The tech-heavy Nasdaq Composite was down 2.8 per cent at noon in New York, while the benchmark S&P 500 was 1.4 per cent lower.

Market interest rates, however, were little changed after the remarks, with the yield on the 10-year Treasury at 1.59 per cent. Yellen recently insisted that the US stimulus bill and plans for more massive government investment in the economy were unlikely to trigger an unhealthy jump in inflation. The US treasury secretary also expressed confidence that if inflation were to rise more persistently than expected, the Federal Reserve had the “tools” to deal with it.

Treasury secretaries generally do not opine on specific monetary policy actions, which are the purview of the Fed. The Fed chair generally refrains from commenting on US policy towards the dollar, which is considered the prerogative of the Treasury secretary.

Yellen’s comments at the Atlantic event were taped on Monday — and she used the opportunity to make the case that Biden’s spending plans would address structural deficiencies that have afflicted the US economy for a long time.

Biden plans to pump more government investment into infrastructure, child care spending, manufacturing subsidies and green energy, to tackle a swath of issues ranging from climate change to income and racial disparities.

“We’ve gone for way too long letting long-term problems fester in our economy,” she said.

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Senior Fed official in line to lead top US banking regulator




Michael Hsu, a senior Federal Reserve official responsible for supervising the largest US banks, is poised to become the next acting comptroller of the currency, ending weeks of uncertainty over the US financial regulator’s leadership.

Janet Yellen, the US Treasury secretary, was set to tap Hsu for a senior post at the Office of the Comptroller of the Currency that would pave the way for him to become acting chief, according to people familiar with the matter. The timing of the announcement could not be determined.

Hsu is currently associate director of the Fed’s bank supervision and regulation division.

He has emerged as a more technocratic choice to lead the OCC compared with other possible choices with higher political profiles, such as Michael Barr, a professor at the University of Michigan and former Treasury official under Barack Obama who was a leading contender for the job. Some progressive Democrats have also been pushing for Mehrsa Baradaran, a professor at the University of California at Irvine, to be selected for the job.

President Joe Biden has not yet chosen anyone to permanently fill the post, which requires Senate confirmation. The White House declined to comment. Yellen’s decision to choose Hsu to lead the agency on an interim basis was first reported by The Wall Street Journal.

Through his role at the Fed, Hsu has great familiarity with the health of the largest banks. The mission of the OCC, which is housed within the Treasury department, is to ensure that national banks “operate in a safe and sound manner, provide fair access to financial services, treat customers fairly, and comply with applicable laws and regulations”, according to its website.

The Biden administration is expected to take a tougher approach to financial regulation than Donald Trump’s officials, amid concerns that hefty doses of fiscal and monetary stimulus flowing through the US economy as it rebounds from the pandemic is fuelling greater risk-taking on Wall Street.

Blake Paulson, the current acting chief of the OCC, was installed by Steven Mnuchin, the former US Treasury secretary, on January 14, less than a week before he left office.

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