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Are negative interest rates the new abnormal?

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A move toward negative interest rates by central banks across the world could affect the sustainability of money market funds, the tightening of lending conditions and result in money being kept ‘under the mattress’.
Speaking today at the annual Nedgroup Investments Treasurer’s Conference in Johannesburg, Ray Wallace CIO at Taquanta Asset Managers, notes that the European Central Bank and countries such as Japan, Denmark, Sweden and Switzerland have moved toward Negative Interest Rate Policies (NIRPs).
“NIRPs have increasingly become a last ditch attempt by Central Banks to halt deflation, stimulate both corporate and consumer spending and boost faltering economies, especially since the global credit crisis of 2008,” says Wallace.
Furthermore, he says the volume of government bonds with negative yields have already exceeded $7-trillion, the majority of which are Japanese bonds followed by Germany and other EU and Scandinavian countries.
Deflation has had a negative impact on several economies because – despite falling prices – consumers often hold back on spending as they wait for the price of goods and services to fall even lower, slowing economic growth. Falling prices also worsen the position of debtors, by increasing the real burden of their debts, and a deflationary environment results in ‘sticky nominal wages’.
The latter refers to the problem that wages, like prices, should fall during periods of deflation but, in reality, are extremely difficult to cut due to socio-political pressures. Wage bill reductions, either through lowering wages or more commonly by cutting jobs, has resulted in social unrest in countries like Greece, for example.
“In theory, NIRPs encourage banks to provide more loans to stimulate spending, rather than holding excess funds on deposit with the Central Bank. However, as we know all too well with macro-economic policies, what works in theory does not necessarily translate to real-world effects,” says Wallace.
He says banks facing negative interest rates are often reluctant to charge depositors negative interest and opt for raising lending rates instead, to maintain profitability. This has the potential to further tighten lending conditions – the opposite of the desired effect.
Another negative impact of NIRPs would be the likelihood of money market funds collapsing, which is evident in the fact that all 11 major Japanese asset managers that offer money market funds have stopped accepting new investments.
Many individual and institutional investors rely on money market funds to hold cash, knowing that they can access that liquidity easily, and that it will maintain a steady asset value, even if it doesn’t generate much yield in a low interest rate environment.
Wallace says if money market funds had to pay to own short-term unsecured promissory notes, or commercial paper, they would not be able maintain a stable net asset value and the economic model breaks down. This may result in investors in these funds preferring to hold deposits at a bank or even cash rather than suffer the drag of negative interest rates and credit conditions would likely tighten as a result.
“In this scenario, the metaphor of money under the mattress becomes a reality and crimes such as robbery, petty theft and money laundering would likely rise substantially,” Wallace says.
As a last resort to unresponsive NIRPs, countries could eventually even look at the possibility of implementing ‘helicopter money’ to boost their economies.
Helicopter money is a concept already being considered by some European and North American countries in which, for example, the government gives a basic income to each of its citizens in an effort to stimulate spending and halt deflation. The phrase comes from the idea that the government is metaphorically throwing money from a helicopter to spread among its people to go out and spend.
“In countries adopting NIRPs, financial institutions and firms are grappling with previously unknown technical, legal and risk management issues thrown up by negative rates. This is forcing them to adapt or redesign their IT systems, redevelop spreadsheets and tax compliance processes, and redraft legal contracts.”
Wallace concludes that although the effects of low or negative interest rates will have an impact on the global economy, including South Africa, the effects are quite far off considering the country’s problems with high inflation, rising interest rates and interesting politics. Therefore the money market proposition for domestic treasurers and investors remains strongly intact.