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A negative acronym not welcomed by the Federal Reserve


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Acronyms dominate the financial market landscape and one that certainly sticks out is Nirp, or negative interest rate policy.

Plenty differentiates the US from other countries — I speak as someone who, until 2015, had lived in New York for 17 years — and this extends to the likelihood of the Federal Reserve following other leading central banks in cutting rates below zero.

Lately, US Interest rate futures markets have reflected the prospect of negative overnight rates determined by the central bank arising next year. The general feedback is one of markets anticipating more stimulus from the central bank, and buying insurance against such an outcome. The US bond market has the muscle memory of how the Fed ultimately cut interest rates during 2019, after initially pushing back against such action from President Donald Trump.

Jay Powell, chairman of the central bank, rejected negative rates during a webinar on Wednesday hosted by the Peterson Institute for International Economics. Rather than go negative, Mr Powell expressed confidence that their current tool kit of asset purchases and various lending programmes were sufficient. Mr Powell also noted that the evidence as to whether negative rates work, was inconclusive, a point that certainly sparks plenty of debate.

Clearly Mr Powell and members of the Federal Open Market Committee are mindful of the problems that negative rates would pose for the vast US money market fund universe and short-term funding markets in general. Not to mention a banking sector currently bracing for defaults on loans. In this regard, Mr Powell said the view of the FOMC had not changed on this issue from an extended discussion held during its meeting in October, which revealed:

“Participants noted that negative interest rates would entail risks of introducing significant complexity or distortions to the financial system.”

Daniel Tenengauzer at BNY Mellon says under a Nirp scenario, “ground zero is $3.9tn in US government money market funds” seen as safe assets.

Money market mutual fund holdings

Daniel writes:

“Assuming interest rates drop below zero would therefore pose a difficult dilemma in government funds. Even if management fees were waived, money managers may pay as much as $10bn each year if rates in these funds were -25 basis points, for instance.”

Over at the European Central Bank, a study from its economists concluded that six years of negative interest rates have been a “broadly neutral” factor for bank profitability. That’s not the judgment of the share market when it comes to eurozone financials, although the sector has been plagued by problems besides negative rates.

Any short-term benefits for banks (such as gains in asset prices on their balance sheets) lose their lustre and in that regard the ECB paper acknowledges:

“In the current euro area monetary policy environment, the effects of a long period of negative rates require continuous and careful monitoring as we venture further into uncharted territory.”

The difficulty in exiting negative rate policy suggests good reasons for other central banks to think hard before following such a path. A nod in that direction by the Reserve Bank of New Zealand on Wednesday, invited a weaker currency.

Earlier on Wednesday I caught up with Dean Turner at UBS and here’s what he had to say on this topic:

“As long as central banks are independent and leading the debate, there will be a great reluctance to implement negative rates given the experience of Japan and Europe. Once you go there, it’s very hard to reverse course.”

Little surprise that Mr Powell stressed the fiscal role required by Congress during his prepared remarks:

“Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery. This trade-off is one for our elected representatives, who wield powers of taxation and spending.”

This plea reflects the worry as expressed by Mr Powell and others of a lengthy and sluggish recovery that is blighted by stubbornly high levels of unemployment, second waves of the coronavirus and the big downside risk of widespread bankruptcies across small and medium-sized businesses, a crucial engine of job creation in the US economy.

Warning that the Fed “has lending, not spending powers”, Mr Powell said:

“The recovery may take some time to gather momentum, and the passage of time can turn liquidity problems into solvency problems.”

Under this scenario and from a bank that has adopted the policy stance of “whatever it takes” to help the economy, some don’t rule out Nirp.

Fred Cleary at Pegasus Capital says:

“If the option is negative rates or Powell’s recently adopted desire for more aggressive fiscal loosening, it will be interesting to see which sides wins out.”

Given how the Fed has repeatedly advocated fiscal sustainability over the past two decades, Fred believes “a quid pro quo” may ensue in the coming months whereby the central bank implements “mildly negative rates” in return for “a further increase in fiscal support”.

Indeed, the FOMC meeting minutes from last October include this line that takes on added significance at the moment:

“Participants did not rule out the possibility that circumstances could arise in which it might be appropriate to reassess the potential role of negative interest rates as a policy tool.”

For investors and markets this only heightens the importance of the economy reaching a bottom in the current quarter. Forecasts for this quarter by the New York Fed and Atlanta Fed, show a sharp decline in the economy.

Nicholas Colas at DataTrek says if this projected second-quarter decline “isn’t a trough, we have bigger problems than trying to figure out financial markets”.

Quick Hits — What’s on the markets radar?

There is no shortage of Covid-19 inspired uncertainty over the economy and that extends to inflation expectations. Liberty Street Economics, a blog written by New York Fed economists notes:

“Inflation uncertainty has remained elevated in recent weeks compared to the pre-Covid-19 period.”

This is highlighted below and is based on roughly 1,300 US households surveyed by the Federal Reserve Bank of New York.

Liberty Street observe:

“The proportion of respondents who think there will be deflation next year (that is, with a density mean below zero) jumped from less than 10 per cent at the end of February to more than 20 per cent a month later. Likewise, the proportion of respondents who expect short-term inflation to be higher than 4 per cent jumped from around 30 per cent to almost 45 per cent during the same period.”

The cold war between the US and China is getting frostier in financial markets. Of little surprise in the current climate, Mr Trump has ordered the main federal government pension fund not to invest in Chinese companies.

JPMorgan estimates that the fund was set to follow the MSCI All World benchmark that has a 9 per cent weighting to Chinese equities and they write:

“Therefore, no change would represent a loss of ~$5bn in potential flow into Chinese equities. While this is not a large number, it is concerning (a) due to the underlying sentiment it reflects, and (b) if such restrictions are extended broadly to government-linked pension plans.”

JPMorgan say that widening the ban to all US federal, state and local government retirement plans (with total assets of $6.7tn) and assuming a one-fifth weighting of international equities, “equates to about $120bn of potential selling in Chinese equities”.

Your feedback

I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.





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