On Friday (01/29/2016), everyone was shocked by the Bank of Japan's announcement:
The Bank of Japan announced it had cut the rate on excess reserves to minus 0.1%, meaning institutions will have to pay the central bank for the privilege of parking reserves that exceed those required by regulators. The rate on most existing reserves, however, remains at 0.1%, while the rate for required reserves was cut to zero (see chart below). Unlike the single negative rate applied to deposits parked at the European Central Bank, the Japanese move is similar to tiered measures put in place by the Swiss National Bank, which punishes sight deposits, or commercial bank assets, of more than 320 billion Swiss francs ($312.5 billion) with a fee of 0.75%.
In this article, we will cover the following topics:
- Negative Reserve Club
- Impacts of Negative Interest Rate
- Is Negative Interest Rate Coming to the US?
- How Low Can They Go?
- How to Protect Your Assets?
Negative Reserve Club
Already, central banks in Switzerland (deposit rate at -0.75% since Jan, 2015), Sweden, and Denmark (overnight rates at -0.75% since 2012) have implemented the strategy. And the European Central Bank’s deposit rate is -0.40%.
No, the BOJ did not increase stimulus on Friday. What they did is joining Switzerland, Denmark and Sweden in the negative reserve club after dropping their rate from 0.1% to -0.1%. However, as commented by Brian Romanchuk on the NIRP (Negative Interest Rate Policy):
The effect on the real economy of marginally lower interest rates is negligible. The only way this announcement will matter is if it helps weaken the yen.
By itself, an interest rate of -0.10% is meaningless; a 10 basis point annual carry loss is less than the daily mark-to-market volatility of foreign currency asset positions for Japanese investors. Negative interest rates will only become significant if they can move below -1%.
In the wake of the BoJ’s decision Friday, the yen plummeted to its lowest level in five weeks against the dollar to ¥121.00 compared with ¥118.84 late Thursday. Japanese yields also hit record lows across curve after BOJ's negative rate shock.
Race to Negative Bond Yields (Click the image to enlarge)
Impacts of Negative Interest Rate
The policy of negative interest rate from Central Banks is supposed to increase businesses' investements and encourage consumer spending. The thinking goes like this:
- Banks have to hold reserves somewhere else instead of in the central banks
- If the risk-free rate is negative, there are immense incentives to borrow and invest.
Recent events have challenged both of these assumptions while sparking a debate over the nature and the import of this collapse in yields. Specifically, is it a brief aberration or the beginning of an unfamiliar and potentially treacherous new normal?
What are the potential problems of negative rates? Some commentators say:
- Negative rates destroy a country’s savings industry and thus its long term growth rate
- Negative rates are essentially a tax on your bank deposits, intended to discourage saving
- Negative rates also raise the risk of a significant disruption to the banking system
- Negative interest rates are a solution for a non-existent problem
- that undermines the demand for money in a way that might have unwanted and inflationary consequences.
- Negative rates are not working in some places
- The European Central Bank began charging banks interest on deposits in June 2014 to encourage them to lend more to companies and consumers. It hasn’t worked.[12,29]
- Many of Europe's banks are "old-fashioned savings and loans" and cannot really pass on negative interest rates to their small savers.
- The feeling is that these small savers would not like to pay to keep their money in these banks and would remove a good portion of them, threatening the existence of the banks.
To sum it up: As Casey Research founder Doug Casey says, this isn’t just wrong, it’s the exact opposite of what’s true. Spending doesn’t drive the economy. Production and saving drive the economy. You have to save to build capital, and capital is necessary for everything.
Is Negative Interest Rate Coming to the US?
It's a fair question to ask. Here are what Fed Reserve insiders have commented on this topic:
"In the event of a serious downturn, negative interest rates are a tool that the U.S. central bank should consider." —Former Federal Reserve chief Ben Bernanke
“Some of the experiences [in Europe] suggest maybe we can use negative interest rates.” —William Dudley, President of the New York Federal Reserve Bank
“Potentially anything – including negative interest rates – would be on the table.” — Janet Yellen, Fed Chair
Earlier on 11/23/2015, senior correspondent Tim Maverick reported that:
As Andrew Milligan, Head of Global Strategy for Standard Life Investments, told the Financial Times, “This is an Alice in Wonderland situation.”
It looks more and more as if the United States will be going “down the rabbit hole” in the not-too-distant future if the economy sours.
On 01/29/2016, Peter Schiff told Business Insider:
"I think the Fed is going to have negative interest rates before the election because we're going to be in a serious recession"
How Low Can They Go?
Negative interest rates are introduced for one of two reasons:
- To defend currency
- To combat deflation and/or a weak economy
David Zervos (the chief market strategist for Jefferies & Co.) thinks the Swiss National Bank can and will go much deeper into negative territory. In so doing, they will give Mario Draghi cover to do the same. How low can they go? At some point it is more cost-effective to build your own vault and store cash than to pay your bank negative interest for the pleasure of keeping your money. David thinks -1.25% deposit rates – or even lower – are feasible.
How to Protect Your Assets?
The rules for successful income investing have completely changed. If you are living (or plan on living) off the earnings of your savings, you better adapt your strategy to the new world of negative interest rates
One obvious side effect of negative interest rates is that they compel retirees, pension funds, and others who need positive cash flow to move further out on the risk spectrum, says Jensen.
“Rather than accepting extremely low rates in government bonds, many fixed-income managers choose high-yield bonds, emerging market debt, and high-dividend equities.”The result, according to Jensen, would be “a broad-based fixed-income asset bubble.”
And even in the absence of financial instability, negative interest rates are potentially good for gold: “It costs around 1% a year to store bullion, which is not an attractive deal when high-quality bonds yield 6%. But when bonds are yielding negative 1%, gold looks much better in relative terms,” says Laggner.
Finally, Bill Gross have also chimed in with the following comment:
Finally, Bill Gross have also chimed in with the following comment:
"I prefer own cash instead of owning the overnight securities which takes away 1% to 1.5% away from me."
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- The Eurozone’s key rate is -0.4%. Sweden’s key rate is -0.35%. Denmark’s key rate is -0.75%. Switzerland’s key rate is -1.1%.
- On Friday, Financial Times reported that $5.5 trillion in government bonds worldwide now have negative rates. That’s about one-quarter of the world’s government bonds.
- According to The Wall Street Journal, countries that account for 23% of world economic output have negative interest rates.
- How is manipulating interest rates different than manipulating currencies?
- Manipulating currencies is a zero sum exercise.
- Manipulating interest rates needs not be zero-sum. It can help spur demand. It trading partners could also respond by easing monetary policy; thus boosting demand further.
- A poll by Asahi Shimbun daily showed 61 percent of people don't expect negative rates will help the economy while only 13 percent said they will.
- A large central bank like the ECB can enjoy a first-mover advantage by being the first to push interest rates below zero. But as other major central banks follow, diminishing returns set in, and the disadvantages could begin to outweigh the advantages.
- Negative interest rates are an imperfect tool, but our bet is that key central banks will continue to deploy them as long as global disinflationary headwinds remain.