What is the best investment when real interest rates are negative?

With some inflation estimates as high as 8%, real interest rates have reached lows not seen in the US since the Second World War. In fact, they went silent.

The real interest rate measures how much interest a person is receiving net of the inflation rate (that is, interest minus inflation). Current estimates have real interest rates between minus 6% and minus 7%.

Usually, investors panic when negative real interest rates appear, because it means they are losing money (in a real sense) by holding safe assets like Treasury bills or Bonds. T. And many speculate that it was this loss of wealth that forced investors into riskier positions.


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We decided to test this phenomenon and see how different asset classes behave when real interest rates turn negative and stay negative for a while.

The result: Historical data shows that when real interest rates went negative, the riskiest asset classes (emerging market stocks, small caps, etc.) performed exceptionally well in the first half of the cycle – outperforms safe assets by more than 1.5 percentage points a month. However, this reversed in the second half of the cycle: On average, the riskiest assets underperformed by one percentage point in the second half of the negative interest rate cycle.


To investigate this, research assistants Jaehee Lee and Natalia Palacios helped me gather interest rate data (based on T-bills), inflation data, and return data for 50 different asset classes. past year. We then examine periods over the past half-century when real interest rates were negative and remained negative for more than a month. We find seven such periods, the average length of which is 2.5 years. Next, we split each such cycle into the first and second halves to examine how the performance of different asset classes compares in the two halves.

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Performance in the first and second half of the negative real interest rate cycle

Average monthly return *

Two notable findings. First, in the first half of the negative interest rate cycle, the riskiest mutual funds perform best. Emerging market funds, US small-cap funds, and international equity funds averaged returns of 1.96%, 1.13% and 1.03% a month, respectively. This is much higher than all other stocks and much better than the average bond fund, which has averaged 0.35% a month return over this period.

In another hand

However, things turned upside down as the cycles matured. In the second half, the riskiest funds underperform. For example, emerging market funds lose an average of 1.13% a month. So while investors were looking for risk in the first half, it seems they were quick to flee from it while the US was in a negative real interest rate environment.

As for the current situation, the current negative interest rate cycle starts in Q2 2020. That means, if our model is correct, a lot of investors could have turned to risky assets. riskier. However, since we’re still in the cycle, nearing the beginning of the third year, it’s not yet known where the first half ends and where the second half begins. So even if we haven’t quite reached the point where investors move out of riskier positions, judging by historical data, that still can’t be too far off.

Horstmeyer is a professor of finance at the George Mason University School of Business in Fairfax, Va. He can be reached at [email protected].

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