These Are Not the Negative Rates You’re Looking For | Lord Abbett
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Economic Insights

Central banks have the ability to lend to banks at negative rates without moving deposit rates at all.

Read time: 2 minutes

On May the Fourth, coincidentally Star Wars Day1, renowned economist Ken Rogoff penned an influential clarion call for deeply negative central bank interest rates as a solution to our current economic crisis.2 Not only would it solve the problem of cash hoarding, he maintained, but also it would allow room for deeper interest rate cuts across the major G10 central banks and let traditional monetary instruments more effectively impact the economy. Everything else – quantitative easing, monetization, “helicopter money” – is just fiscal policy in disguise, according to Rogoff.

The piece sent a flurry of self-introspection throughout major central banks. UK two-year yields eventually turned negative. Fed fund futures priced the possibility of negative rates for a brief moment. Dozens of sell-side articles opined on the efficacy and probability of negative rates at the Reserve Bank of Australia (RBA), Bank of England (BoE) and the U.S. Federal Reserve (Fed).

But we believe negative short-term interest rates come with a number of problems, including, but not limited to:

  1. They are very disruptive to money market funds.
  2. Depending on the structure of the banking system in question, negative rates reduce net interest margin and bank profitability, with some implications in the long run for the cost of credit. The structure of bank funding also affects how much pass-through there will be to the rest of the economy.
  3. Deeply negative interest rates require a predominantly digital cash society. India’s experience with eliminating large bills shows society may not digest this particularly well. That is not to say there are no other alternatives:
    • You could have a rate of exchange between paper and electronic currency, with paper currency depreciating over time;
    • You could impose a negative rate on banks’ excess paper currency withdrawals;
    • But these may or may not entail quantity restrictions on cash and other side effects, like reduced bank profitability.
  4. Telling people for years you don’t like negative rates (as the Fed has done) and then caving-in is not a great confidence-building strategy.
  5. While there may be short-term stimulus from negative rates, over the long term they may require higher savings rates to achieve households’ wealth objectives.

Not a Mind Trick: Negative Rates without Cutting Deposit Rates

Given all of the above, central bankers are warming up to the idea that they have a more powerful “force” at hand: the ability to lend to banks at negative rates without moving deposit rates at all. This means deposit rates aren’t the negative rates you are looking for.

The European Central Bank (ECB) already does this through deeply negative targeted longer-term refinancing operations (TLTROs), which offer banks long-term financing (conditional on lending) at a rate of 50 basis points (bps) below the deposit rate. The Bank of Japan (BoJ) implemented something similar by offering funding to banks who conduct lending to credit-needy firms. In return for this lending, the BoJ also pays these banks a positive rate on their current account balances with the central bank (notable because of current negative deposit rates in Japan), meaning the banks are effectively provided funding at a negative rate. In other words, the BoJ found a way like the ECB to lower the cost of bank funding without lower official central bank rates.

As such, we expect other central banks to consider this policy. The BoE may potentially offer banks lending through its Term Funding Scheme at negative rates. The Fed took a step in this direction by making the terms of discount window lending more favorable (but not negative just yet). Lastly, the RBA may embark on negative lending to banks through its Term Funding Facility.

In short, we shouldn’t be looking for central banks to begin setting negative rates through monetary policy, in my view. We should be watching their negative lending to banks.

 

1May the Fourth is the day chosen by Star Wars’ fans as an annual celebration of the space fantasy saga.  The date was chosen for the pun on the catchphrase “May the Force be with you” as “May the Fourth be with you.”

2Kenneth Rogoff, “The Case for Deeply Negative Interest Rates,” May 4, 2020, www.ProjectSyndicate.com

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Glossary of Terms

A basis point (bp) is one hundredth of a percent. 

Helicopter money is a term coined by the late Nobel-prize winning economist Milton Friedman that refers to a last resort type of monetary stimulus strategy to spur inflation and economic output.

Monetization is a two-step process whereby the government issues debt to cover its spending and the central bank purchases the debt from secondary markets and perpetually rolls it over, leaving the system with an increased supply of money.

Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment.

The targeted longer-term refinancing operations (TLTROs) are Eurosystem 0perations that provide financing to credit institutions. By offering banks long-term funding at attractive conditions they preserve favourable borrowing conditions for banks and stimulate bank lending to the real economy.

In August 2016 the Bank of England’s Monetary Policy Committee announced a package of measures, with mutually reinforcing elements, to support growth and return inflation to target. The measures included a Term Funding Scheme (TFS), which provided funding to participating banks and building societies at interest rates close to Bank Rate.

The Reserve Bank of Australia established a Term Funding Facility (TFF) to offer three-year funding to authorised deposit-taking institutions (ADIs). The intent of the facility is to reinforce the benefits to the economy of a lower cash rate, by reducing the funding costs of ADIs and in turn helping to reduce interest rates for borrowers and to encourage ADIs to support businesses during a difficult period.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.  If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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