The “experts” were and indeed are not ready for negative interest-rates

Whilst negative interest-rates are not an outright new phenomenon they are being applied right now on an unprecedented scale. As the Bank of England’s Underground Blog reminds us.

one quarter of world GDP now comes from countries with negative central bank policy rates.

There are a load of consequences from this. Let me open with one which is not publicised as much as it should be. It is that interest-rates (and indeed bond yields) are held down elsewhere by the fact that a rise would lead to currency inflows and likely appreciation as they are compared to the negative rates elsewhere. It has become another component of what has been labelled the currency wars. A feature of this has been the way that the US Federal Reserve has progressed at slower than a snail’s pace in raising US interest-rates as we are nearly in June but have seen so far none of the 3-5 interest-rate rises promised at the turn of the year. Interest-rate rises such as they occur are mostly in response to currency crises these days. By contrast Reuters records this.

Ukraine and Moldova cut rates again today, making it 11 central banks to ease in May alone. 53 since start of last year.

How do people respond to negative interest-rates?

Sweden is one of the nations involved and in fact has the lowest rate so far as whilst the headline is -0.5% the Riksbank also has a deposit rate of -1.25%. This week has seen some news which confirms one of the themes of this blog but first let us let the central bankers have a brief moment of fun in the sun. From Sweden Statistics.

In April households’ loans from Monetary Financial Institutions (MFIs) had an annual growth rate of 7.7 percent, which is 0.2 percentage points higher than in March. Households’ loans from MFIs totalled SEK 3 369 billion.

Central bankers around the world will smile at the way that negative interest-rates have led to a surge in household borrowing. The smile gets even broader when they read a little further down.

The increase is mainly due to housing loans, which increased by SEK 217 billion compared to the corresponding month last year, and amounted to a total of SEK 2 758 billion in April. Housing loans had an annual growth rate of 8.5 percent in April, unchanged compared to March.

So all the Christmases of central bankers have arrived at once it would appear. Cutting interest-rates leading to an economic surge? Er well maybe not as the Shaun critique comes into play. Remember my posts on savings where I have argued that lower interest-rates makes some save more? Well on Monday we got evidence of that.

Households’ financial savings, new savings minus increase in debt, amounted to SEK 58 billion during the first quarter of 2016.

Yes you did read that correctly as the Swedes were net savers in the first quarter of 2016. This is where they put the money.

Households mainly saved in insurance and deposits and made net sales of shares and funds. Net deposits, mainly in bank accounts and tax accounts, amounted to SEK 38 billion, a record level for the first quarter.

The increase in bank savings ( SEK 23 billion) back my argument that cutting interest-rates leads part of the population to save more not less. This offsets the conventional view which only seems to look at the increased borrowing and in this instance ignores the fact that there is net saving going on. Also the plan to get people to shift in to assets seems to be working for houses but not investments “net sales of shares and funds.”

Accordingly we see a complex situation which on the surface seems to back what we might call central banking economics 101. But once we go below the surface we see a familiar argument which is that yes it “works” but that there are offsetting forces which yet again appear to be larger. No wonder central bankers do not always get what they want and struggle to get what they need as well.

They do not apply everywhere

We do not have to step back that far in time to discover a different view of the world from a man who was responsible for much of the work in the derivatives world which provided my occupation and job. From the Bank Underground blog.

n 1995, Fischer Black, an economist whose ground-breaking work in financial theory helped revolutionise options trading, confidently stated that “the nominal short rate cannot be negative.”

You could argue he was already wrong although equally you could argue that Switzerland in the 1970s was a tax on cash especially for foreigners. However let is move on with a number which was not supposed to happen.

According to the BIS, the total notional outstanding of global FX, interest rate and equity-linked derivatives rose from $72 trillion in 1998, to $522.9 trillion in 2015. ( BIS = Bank for International Settlements).

Remember when as the credit crunch hit we were promised that this sort of thing would be curtailed? Perhaps that is why one of the main players, Deutsche Bank, remains so troubled. If we move on we see that there is a link between this and negative interest-rates.

The vast majority (nearly 80%) are interest rate derivatives whose theoretical underpinnings are often predicated on the assumption that risk-free rates are bounded at zero. These baked-in assumptions have made it more complicated for financial markets to adjust to life below 0%, particularly where derivatives were priced and risk-managed as if negative rates were not possible.

That needs to sink in as a group of highly paid people who were are so often told need to be paid so much because they are the “brightest and the best” see their intellectual Titanic hit the rocks and in some cases hard. There have been some technical fudges to help deal with the consequences of this but the market based response was fascinating.

The obvious hedge was to protect oneself against lower rates and higher volatility, for instance by buying bonds, entering interest rate swap contracts, and buying options……However the process of hedging likely amplified the fall in yields,

So problems with negative interest-rates helped lead to negative bond yields! What could go wrong?

Floating Rate Notes (FRNs)

These have had their Houston we have a problem moment.

Legal and operational practicalities have meant FRN coupons are effectively floored at 0%.

Ah, more signs of “genius” at work. This provides yet another problem for central banking 101.

This 0% floor is important. As noted by Ippolito, et al (2016), FRNs are a significant channel through which the monetary policy transmission mechanism works.

Or rather they are not in this instance. The companies involved also have some Taylor Swift style “trouble,trouble,trouble.

But companies must contend with the prospect of having the cost of their FRN liabilities floored at 0%, whilst seeing returns on investible assets fallbelow zero.

This is mostly an issue in the Euro area right now and here is an estimate of the scale.

At present, €350bn of euro-denominated FRNs referencing Euribor (28% of total outstanding) are affected by this 0% floor. If Euribor falls by a further 25bps, we estimate that around half of all EUR FRNs would be affected (~€670bn).


There is more than a certain irony in the fact that the group who were the supposed experts on interest-rates have been proven spectacularly wrong. We have gone where they argued we could not go. I remember the arguments in the late 90s as I was there but what troubles me the most was the failure to adjust post 2007 which is nearly a decade ago now. We see so little thinking and planning ahead and accordingly the “experts” suffer so many surprises.

What we suspected and believed on here was that negative interest-rates would have a succession of unintended and unwelcome consequences has proven to be true. This matters increasingly as I note this from Robert Skidelsky in Wednesday’s Guardian.

Enter negative interest rate policy. The central banks of Denmark, Sweden, Switzerland, Japan, and the eurozone have all indulged. The US Federal Reserve and the Bank of England are being tempted.

The latter section caught my eye as is they way he was described. Do you think both he and the Guardian had forgotten he is Baron Skidelsky and could not be much more well-connected?






24 thoughts on “The “experts” were and indeed are not ready for negative interest-rates

  1. Shaun,

    While we’re celebrating the achievements of our CB classes in creating crises and still not managing to see them coming,do you have a comment regarding the net migration figures released yesterday showing the annual rate at +333,000.

    It’s pertinent because amongst their many other well known failings,GDP is almost always referred to without reference to population growth.

    I’m just going to go for a few failings off the top of my head-imputed rents(it’s only 11% of GDP after all)-using the claimant count for unemployment(I was talking to a 58 year old lady yesterday whose husband is in work and isn’t entitled to benefits)-various inflationary shenanigans covered on here over the years- etc etc

    Can I add GDP per capita to the list of flagrant offences against common sense or am I being harsh?

    • Hi Dutch

      The latest GDP per capita figures told us this.

      “GDP per head in volume terms was estimated to have increased by 0.2% between Quarter 4 2015 and Quarter 1 2016.”

      There is likely to be a migration effect on this but hours worked by the existing population are also a factor.

      As to the migration numbers themselves we simply do not know that. A major source is something I regularly challenge in its other forms.

      “Latest employment statistics from the Labour Force Survey show the estimated employment level of EU nationals (excluding British) living in the UK was 2.1 million in January to March 2016, 224,000 higher than the same quarter last year.”


      “Long-Term International Migration (LTIM) estimates are mainly based on data from the International Passenger Survey (IPS), with adjustments made for asylum seekers, non-asylum enforced removals, people resettled in the UK under the various resettlement schemes, visitor and migrant switchers and flows to and from Northern Ireland. ”

      So yes we have a number but its accuracy needs questioning..

  2. $522 trillion of derivatives out there. What could go wrong?
    At least we are safe in the UK, as the Establishment already knows our exact household income in 2030.
    We are very lucky in our leaders and we should be more openly grateful to them!!

    • James

      I suspicious that all these derivatives are backed off to each other in one way or another .

      net result = 0 , minus charges ofcourse *


      * called scam or fraud ( ponzi) in the old days before 2007

    • Technically most derivatives net off against each other however we all know that in practice it only takes one big player to fold and chaos will ensue.
      A friend who worked at a big New York bank that collapsed told me they had no definitive way of actually measuring their exposure such was the complexity of some of the arrangements.
      Also worth noting that mal fides on a brokers part could stop a counterparty being able to settle .
      It’s funny how often Deutsche get a mention in this respect

  3. Hello Shaun ,

    Well ,

    “the failure to adjust post 2007 which is nearly a decade ago now.

    We see so little thinking and planning ahead”

    Its either that there is thinking and planning , watch what do , not say


    there isn’t…….(erm..)

    I’d posit either way that they are up the *&*&! creek with out a paddle and drifting to the shore where a rather large hungry bear awaits them…..

    Frankly you see this in other groups – what worked yesterday will work today …… until it doesn’t and then they all stand around wondering whats going ( and then assuming its because they did not ask for enough money ….. )


    Central Banker #1
    Bloody ‘ell! That’s what I call thinking! Why do we never think of things like that?

    Central Banker #2
    Dunno. Think our minds must be too highly trained……

    ( credits Douglas Adams )

    • Hi Forbin

      There is always a lag in response to a fundamental change as everybody hopes/assumes that the status quo will return. In a way I can excuse the early QE of 2009 to some extent on that front. However as you point out central bankers seem to be from a group who do not learn anything even over a decade later. Indeed they still cheer lead for each other as this from Harvard about Janet Yellen’s speech there yesterday tells us.

      “During her remarks, she praised Bernanke for his leadership during the 2008 financial crisis and his “inventive and innovative” approach to getting credit flowing back into the American economy, as well as for the Fed’s programs, asset purchases, and other efforts to get the economy back on its feet.”

      Of course she is also praising her own past actions.

        • Hi Eric

          Are there two Charlie Bean’s? Otherwise there have been a few contenders for toadying of the week.

          “Rupert Harrison ‏@rbrharrison May 23 Paddington, London
          Interesting tht Charlie Bean has agreed to publicly sign off the HMT Brexit analysis today. Probably our most eminent living macroeconomist”

          “Tony Yates ‏@t0nyyates May 23
          @nsoamesmp I know the HMT people. Clever, hard-headed people of integrity. And Prof Charlie Bean also backed their report.”

          Numbers in shock doc “reasonable estimates of likely size of short term impact” economic authority Sir Charles Bean”

  4. I think that negative rates are simply the last gasp of a failed system and a symptom of intellectual bankruptcy, although not blind consistency.

    To my mind the fundamental failure here is to fail to recognise that the difficulties we face are structural and not cyclical and that monetary policy is an inappropriate tool to use under these circumstances.

    Demography and a slackening of productivity, exacerbated by the cyclical downturn since 2008, mean, in my view, that the state of “normalcy” which policy is targeting simply does not exist and that sustainable growth may indeed be materially lower than hitherto. The only result of this monetary pumping is what we see: inflated asset markets.

    Unfortunately the implications of the structural situation we face, together with other looming issues such as robotisation, are very unpalatable to our leaders and they will do anything to avoid the (in my view) inevitable consequences of substantial reform. They prefer to crash the present system, leaving chaos and destruction in their wake rather than face these consequences.

    • Hi BobJ

      It was strange in a way to see Lord Skidelsky make a similar point about monetary policy. Of course he argues for a fiscal stimulus. However that argument invariably ignores that we have had an ongoing fiscal stimulus and then starts to sound rather like the central bankers.

    • Structural causes yes. Globalisation is benefitting growing middle classes outside the first world, but it is also lowering living standards in the first world, especially for the unskilled.

      The ponzi state pension schemes looked managable when the baby boom made pensioners a smaller proportion of the population but it looks unsustainable now. (don’t shoot the messenger)

      But I’d suggest that robotisation may increase living standards – resources and population growth permitting. The luddites thought auotmating weaving would reduce living standards – yet our living standards have improved massively as a result of technologies that improve productivity.

      • I think the issue with robotisation is that it will not necessarily cause unemployment but it will change the structure of the labour market by hollowing out the middle and leave a more polarised market and, as a consequence, exacerbate the problem of inequality. It’s a major issue either way.

  5. These derivatives pose a systematic risk to the investment banking industry. None of whom is able to know who their counterparty is and whether that counterparty is able to pay. Hence the Liars poker put on the taxpayers.

    If an individual opens a spread betting account, small scale derivative bets are possible, but the bookie holds enough credit to cover foreseeable losses. And in a spread betting account – chances are that they can stop loss (or stop gain) in the event of “large” market moves. The holding of adequate credit and a limit on market moves provide protection against systematic losses for the spread betting company.

    Looking at the spread betting company’s protection from insolvent counterparties – I would ask how can the regulators encourage the TBTF banks to enter into similar settlement schemes ? How can they foist the risks onto the banks, and let the banks know that in the next crisis – the insolvent will join Lehmans …..

    I’d even suggest that it is in the investment banking sectors own long term interest to create a common settlement system that reduces counterparty risk. A positive position is profitable only if the counterparty or bill paying settlement agency is SOLVENT …. and they should take lessons from what happened to the Icelandic banks.

    • The derivatives in the gold market are 100 times the physical market; the vast majority of sell contracts are not capable of being fulfilled. What we have in this, as in many, other markets is an inverted pyramid with a small “physical” component at the bottom a a vast speculative component on top; effectively a “horde” – an appropriate term – of people trying to rip each other off. Is this really what it’s all about?

      • …and this can only really be done in a digital universe. Would you rather have a lump of gold in your pocket or a tenuous claim to a few bits and bytes in the computer of a bank that could easily disappear in seconds if (when) a trigger event happens?

      • Yes, it’s a casino. The gamblers should not expect tax payers to cover losses when losing gamblers go broke.

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