A new age of Euro and bank stocks, and insurance policies

DNHN - The European Central Bank introduced a negative interest rate policy (NIRP) in June 2014 when it first decided to cut the base interest rate below 0%, at -0.1%. Since then, the ECB has cut its base rate four more times, 10 basis points each, to -0.5% in September 2019 and has maintained it until now, however the base rate policy negative basis may soon change.

When European benchmark interest rates fell to zero in 2014, fixed-income professionals were forced to explain to befuddled bond investors how they could be compensated for allowing governments to borrow money and how investors who borrow from banks might earn additional more. To assist economies in weathering the 2008 recession-related problems, the European Central Bank (ECB) implemented a negative interest rate policy (NIRP) in June 2018. 

In 2014, the decision was made to decrease the basic interest rate below zero percent, to -0.1 percent. Since then, the ECB has lowered its base rate four more times by a total of ten basis points, bringing it to -0.5 percent in September 2019 and remaining there till today. 

By making it more costly to hoard capital than it is to generate cash flow, investors quickly find themselves paying several governments and businesses for their money. 

Savers grumble that the deposit charge is robbing them of their riches, yet by the end of 2020, 75% of eurozone sovereign debt on Tradeweb's platform – around 6.7 trillion euros ($7.45 trillion) – will still have a negative return.

After almost a decade, the Euro has entered a new phase, with the base interest rate on course to increase beyond 0%. 

Younger investors will now need to adjust to a new interest rate environment. 

In the past, we had to educate people about negative rates," Hampden-Turner, an expert at FTSE Russell. 

Now, we're going to have a whole new generation of young investors who are only familiar with negative yields.  

“Everything shifted abruptly. Increased profits might entice investors back to the area, boosting the euro and relieving pressure on banks and pension funds.”

The group that is now more likely to experience losses comprises developing and riskier corporate bonds that were acquired in the pursuit of profit.

Money markets are already responding to the European Central Bank's (ECB) action, as the bank outlines a plan to return the base interest rate to positive territory by the end of 2022 as monetary policy tightens. This is in response to the region's record high inflation after the epidemic. 

On Tradeweb's platform, less than a third of eurozone debt now has a negative yield, while Deutsche Bank estimates total global debt has dipped below $3 trillion for the first time since December 2015, from a 2020 top of more than $18 trillion. 

Germany's 10-year bond yields surged over zero in January for the first time since 2019 and are now at 0.56 percent. 

This week, the country's two-year bond yield crossed 0% for the first time since 2014, peaking at 0.068 percent despite the fact that it only lasted two days, eventually ending at -0.059 percent on Friday, which is still the highest level since 2014 and has been climbing steadily since March 2022 began. 

The ECB implemented an unprecedented negative interest rate policy in response to the massive rise in outstanding loans, the stock and real estate market booms of 2008, and the economic slump that followed. 

Negative interest rates have harmed pension funds and insurance firms, which assess future debt using historical bond returns. These funds can no longer earn money by investing in government bonds and are compelled to increase their risk exposure. 

According to a 2019 IMF research, large pension funds have more than quadrupled their exposure to alternative and illiquid assets since 2007. Negative base rates erode banks' earnings by reducing net lending margins. 

Euro zone banking equities have plummeted almost 40% since 2014 (.SX7E), while Japanese bank stocks have declined 10% since interest rates in the country dipped below 0% in 2016. (.IBNKS.T). As short-term bond rates fell below 0% this week, euro zone bank shares surged roughly 4%.

According to Secker, each ECB rate rise may contribute 10% to lenders' earnings per share – and up to 20% in Southern Europe. Along with the banking sector in Europe, insurance businesses too have a fantastic potential to turn things around. 

According to Viktor Hjort, director of global credit strategy at BNP Paribas, insurers held 30% of European corporate bonds in 2016, but just 22% presently, as the ECB regains dominance shortly. 

Due to capital benefits, they have become significant investors of European bonds. “As an insurance fund, your investment choices grow considerably,” said Helene Jolly, Deutsche Bank's head of investment-grade corporate debt in EMEA. 

Investors have returned in search of higher-quality debt. However, given the ongoing political tensions between Russia and Ukraine, and the ECB's goal to raise the base interest rate from -0.5 percent to 1% in 2023-2024, the ECB may adjust inflation to the target level. 

Nguyen Dung