US President Donald Trump has renewed his call for easier monetary policy from the US Federal Reserve, calling for rates to be reduced below zero. In a speech to the Economic Club of New York, President Trump said negative rates gave other countries a competitive advantage over the US complaining that "our Federal Reserve doesn't let us do it."
But we believe the rewards from negative rates have so far been relatively modest, while the downside is increasingly evident.
- Negative policy rates in the Eurozone, Japan, and Switzerland are essentially a function of lack of demand, and an excess of savings versus investment. These policies, combined with asset purchase programs, have pushed market interest rates lower and flattened yield curves. Political uncertainty, such as the US/China trade and technology dispute, only amplifies this dynamic as investment decisions are postponed or delayed. Recently the de-escalation of trade tensions and reduced risk of a hard Brexit have led to some economic stabilization, a bounce in yields and a re-steepening of yield curves, however this has to be viewed in a cyclical context versus the longer term structural imbalances.
- The long term economic record of negative rates has been mixed at best. The Bank of Japan (BoJ) introduced negative interest rates in 2016, lowering the deposit rate to -0.1%. Growth rates have remained subdued and inflation below the central bank's target. A recent paper by the San Francisco Federal Reserve observed that when the BoJ announced plans to enter negative rates in 2016 inflation expectations actually fell, rather than rose, as policy makers had hoped. There is limited evidence in Japan that years of negative have improved lending growth.
- The pernicious side effects of negative rates are coming to be more widely appreciated. Negative rates can be harmful to the financial system, with commercial banks forced to pay to park assets with the central bank. The European Central Bank has introduced a system of tiering to mitigate this impact, but it is not clear the downside can be fully offset. Negative or ultra-low rates are also a drag on the income of savers. Here savers are faced with two choices, either take greater risks in order to meet desired return objectives or perversely increase the amount that they save and reduce consumption. In Switzerland, for example, a survey of 2,500 companies by UBS found that nearly two-thirds believed the economic costs to the economy outweigh the benefits. Meanwhile, the Riksbank in Sweden, an early adopter of negative rates around five years ago, said in October that it would aim to bring rates back to zero by the end of 2019, warning of rising risks if the policy becomes entrenched.
So, negative rates have not proved the great advantage that President Trump’s comments might suggest. Our view is that a further move towards negative rates in the Eurozone or Switzerland will meet stronger resistance. That said, we do expect rates globally to remain lower for longer, with the Fed on hold and the ECB remaining accommodative. Under these circumstances, we favor carry strategies and we are overweight USD-denominated emerging market sovereign bonds.
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