A $630 Billion Pension Market Set to Enter a New Rate World

(Bloomberg) -- Sweden’s pension industry is about to get its first taste of life after negative interest rates.

Funds with a total of about $630 billion in assets have a lot at stake as their central bank becomes the first to exit the experimental monetary policy. With the rest of the world watching, the Swedish Riksbank is expected to raise its benchmark repo rate from minus 0.25% to zero on Thursday, ending half a decade of negative rates.

The policy lasted “far too long,” says Richard Grottheim, the chief executive of AP7, which oversees more than $50 billion in assets from Stockholm. Getting back to zero “will make it easier for us to invest short term, where the No. 1 risk no longer will be that the nominal value of cash gets eroded.”

He says five years of a regime that made it normal for lenders to pay borrowers “has created a strange situation in the rates market.”

Since their introduction as a remedy to persistently low inflation after the financial crisis, negative rates have become an increasingly controversial tool. In Sweden, they haven’t quite revived inflation to the Riksbank’s 2% target, while economic growth prospects have dimmed. Meanwhile, the krona has tested record low levels.

What’s more, banking as a business model has been turned on its head, as have age-old savings models.

“The negative repo rate and purchases of government bonds have worked well and had a positive impact in the economy. But if negative nominal interest rates are perceived as a more permanent state, the behavior of agents may change and negative effects may arise,” the Riksbank said in October.

Most economists who watch the bank expect it to stay on hold once the benchmark repo rate has been returned to zero.

The question then becomes how different zero is from minus 0.25%.

“By lifting rates to zero, at least it’s not as extreme as it has been,” said Tony Persson, the head of fixed income and currencies at Alecta, which oversees almost $100 billion in assets. “The Riksbank seems to realize that there’s a cost associated with negative rates.”

But the reality is that there will continue to be “substantially negative real rates,” Persson said. And they will probably last “far into the future.”

“One shouldn’t dramatize a hike from minus 0.25% to zero,” he said. “Extremely low long-term rates” remain a “bigger and more genuine problem,” he said.

The subzero-regime has been great for borrowers, but brutal for a pension industry struggling to generate the returns needed to cover growing obligations.

The yield on Sweden’s 10-year government bond is just above zero, with all shorter maturities trading at negative yields. The Riksbank has so far committed to bond purchases until the end of next year. According to SEB AB, 35% of those polled in an internal trading-room survey expect the Riksbank to extend its so-called quantitative easing program beyond 2020.

Persson says it would be “healthy if central banks would back away from intervening in government bond markets.”

--With assistance from Love Liman, Niclas Rolander and Frances Schwartzkopff.

To contact the reporter on this story: Rafaela Lindeberg in Stockholm at rlindeberg@bloomberg.net

To contact the editor responsible for this story: Tasneem Hanfi Brögger at tbrogger@bloomberg.net

©2019 Bloomberg L.P.