Negative Interest-Rates are arriving in the United States

Today brings into focus a subject we find ourselves returning to time and time again. It has been a road paved with official denials followed by U-Turns which are often presented as being forced on the central bank concerned. So the playlist is as follows.

1. Negative Interest-Rates are not going to happen
2. I am not a fan of Negative Interest-Rates ( these days added to by concerns over their effects)
3. There is the imposition of Negative Interest-Rates in response to a crisis
4. Research is produced to show that the cut into Negative Interest-Rates is part of global secular trends and is nothing at all to do with the people who just voted for it.

Of course should stage 4 actually work then it will be pronounced as a triumph for the central bank involved. Should that ever happen I will be sure to let you all know. We have seen the reverse as the Riksbank of Sweden has gone from -0.5% to 0% as the economy slowed. Indeed as you might expect things are deteriorating.

Household consumption decreased by 3.1 percent in March, compared with March 2019 measured in fixed prices and working day adjusted figures.  ( Sweden Statistics)

But they have been lucky in PR terms as first the problems with the unemployment series and now the Covid-19 pandemic have been smokescreens. After all Sweden has kept more of its economy open so will appear to have done better for a while.

Returning to my stages the quickest move from 1 to 3 I can think of was in Japan where Governor Kuroda imposed negative interest-rates only eight days after denying any such intention.

The US Situation

As you can see some of the factors above were in play only yesterday.

WASHINGTON (Reuters) – Atlanta Federal Reserve bank president Raphael Bostic said he is “not a big fan” of negative interest rates.

Negative rates are “among the weaker tools in the toolkit,” Bostic said in webcast remarks, reiterating the broad view among Fed officials that the U.S. is unlikely to use a policy approach currently used in Europe and Japan.

Some traders see negative rates as a possibility as the Fed battles the economic fallout from the coronavirus pandemic, though Fed officials have generally opposed the idea.

As you can see this is not a full official denial but he is indulging in some PR which means that should he vote for them he can say he was in some way forced to. At the moment he is a non-voter but that changes next year.

He was not the only Federal Reserve member on the case yesterday so let us see if he sticks to his views and move from Atlanta to Chicago.

FED’S EVANS DOES NOT ANTICIPATE NEGATIVE INTEREST RATES WOULD BE USED AS A TOOL IN THE UNITED STATES ( @PriapusIQ )

This is not quite what he has said in the past as back in March 2014 it was reported that after a speech he said this.

Fed would have made interest rates negative if possible ( Forexlive)

If we are looking for an official denial then we may note this from the Wall Street Journal over the weekend.

Federal Reserve officials are unlikely to consider using negative interest rates to stimulate economic growth in the current coronavirus-induced downturn after concluding the tool’s clear costs outweigh its uncertain benefits.

Research

The Chicago Fed published a paper on it last year and one opening salvo is bad for the Bank of Japan and ECB.

Significant stimulus from NIRP requires very large cuts in policy rates. Such large cuts into negative territory have not been attempted in practice for a variety of political and
financial reasons.

In fact they seem to be trolling the ECB to some extent.

Fixing other parameters but increasing the size of the
central bank’s steady state balance sheet to 38% of GDP (which matches the Euro area as of the end of 2018), NIRP actually becomes mildly contractionary.

With the ECB back in full expansion mode ( another 42 billion Euros of sovereign bonds bought last week) that looks rather ominous.  Indeed they go further and suggest that more QE would make NIRP more difficult.

Negative policy rates are essentially a tax on the holders of reserves. The more reserves there are, the more punitive
is this tax, and at some point intermediaries might find it undesirable to continue.

That is rather awkward as the relative size of the US Federal Reserve balance sheet is heading to those sorts of levels. Also let me move you on from the 2019 research to May 2020. The ECB has adjusted to the reserves issue by doing this.

Moreover, for counterparties whose eligible net lending reaches the lending performance threshold, the interest rate over the period from June 2020 to June 2021 will now be 50 basis points below the average deposit facility rate prevailing over the same period.

Or more simply it is a case of “The Precious! The Precious!” as banks can access funds at -1% to offset the issue of having to pay -0.5% on other reserves. Central banks can be incredibly innovative when it comes to helping the banks.Oh and I am using  the definition of innovative from my financial lexicon for these times which notes that the Irish banks which collapsed were renowned for innovation.

Why now?

We noted this in late March.

On Wednesday, yields on both the one-month and three-month US Treasury bills fell below zero, joining a slew of government debt around the world with yields in negative territory. It was the first time both bills went negative at the same time since their yields briefly fell to -0.002% each four-and-a-half years ago, CNBC reported.

We have moved away from that since but at around 0.1% not far away as we remind ourselves that “Not QE” involved buying US $60 billion of US Treasury Bills a month. Then there was this.

May 7 (Reuters) – U.S. fed funds futures contracts have begun pricing in a slightly negative fed funds rate in 2021, as the U.S. economy contracts due to business shutdowns designed to stem the spread of the new coronavirus.

The situation ebbs and flows but when I checked earlier we still had futures prices above 100 from April to August next year, or if you prefer negative interest-rates.

Comment

There are several subplots here. Firstly if negative interest-rates had worked we would be swamped with central bank literature on the subject, so its absence is telling. Also such references as there have been have muddied the waters as for example when Mario Draghi combined the impact of a -0.5% interest-rate with QE.

Next comes the problems some of which were highlighted by the Chicago Fed back in 2014.

The fear is that excessive and persistently low interest rates would lead to excessive risk-taking by some investors. For instance, some firms, such as life insurance companies and pension funds, are under pressure to meet a stream of fixed liabilities incurred when interest rates were higher.³ (And perhaps these liabilities were offered at somewhat generous terms to begin with.)

For central bankers to suggest others should have seen the future more clearly really is a bit of a joke. So let me finish with the best joke I can think of on this subject courtesy of Kenneth Rogoff.

 Suppose central banks pushed back against today’s flight into government debt by going further, cutting short-term policy rates to, say, -3% or lower.

He thinks it would do this.

For starters, just like cuts in the good old days of positive interest rates, negative rates would lift many firms, states, and cities from default.

Nobody seems to have told our Ken about the contracts he has just imploded, On fact some might implode and explode simultaneously. So he would be reaching for his John Lennon albums.

Nobody told me there’d be days like these
Nobody told me there’d be days like these
Nobody told me there’d be days like these
Strange days indeed — strange days indeed