Negative Interest Rate Policy: Life Below Zero

Negative Interest Rate Policy: Life Below Zero

We’re now up to five central banks that have adopted a negative interest rate policy (NIRP), and the world’s markets are concerned that others might follow suit. Even the U.S. Federal Reserve has discussed the possibility of negative rates. But how serious is the risk from such policies and might they one day become commonplace?

Economists from at least one firm suggest that NIRPs may one day be considered just another tool in policymakers’ bag of tricks rather than an act of desperation.

Are the markets ready for increased use of a negative interest rate policy?

In a Feb. 26 report titled “Life below Zero,” HSBC analyst Steven Major and team argue against the widely-held view that adopting a negative interest rate policy is generally bad. They also see more room to run into negative territory if central banks want to do it, although they add that the recent turbulence indicates that the markets are exhausted with the idea of negative interest rates and skeptic about whether they will even work in reversing negative inflation.

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However, the HSBC team thinks the markets might be wrong about whether there’s really more room to move further negative on interest rates. They add that in the past, “unconventional” monetary policies have included zero interest rate policies, quantitative easing and forward guidance.

Unconventional becomes conventional

The Fed dipped its toe into the water by adopting a QE policy a few years ago, and now we have some central banks with zero interest rate policies. Forward guidance is a tool that’s now commonly used by the Fed, which indicates that what was once conventional in monetary policies can become standard and even an important tool used by central banks.

What’s particularly interesting about the Fed mentioning negative interest rates recently is the fact that they just raised rates late last year. The recent notes from the Federal Open Market Committee indicate a very high level of uncertainty. While it’s true that U.S. economic data has been mixed, moving to a negative interest rate policy now would require a complete reversal of stance. At this point it seems like the Fed is far more likely to just slow rate hikes rather than reverse course.

The problems with a negative interest rate policy

Of course there are several things keeping NIRPs from becoming standard fare, two of which are bank profits and cash substitution. The HSBC team adds that these two problems must be overcome in order for NIRPs to go much further than they already are. Banks have found ways on their own to deal with how negative rates eat into their profits in some of the countries where a negative interest rate policy is in effect, but their current methods are nothing but a fragile dam that could break if their countries’ central banks move further into negative territory.

negative interest rate policy


However, NIRPs aren’t all bad, the HSBC team argues. Major and team suggested that one day we might see a negative interest rate policy as being “just an extension of monetary currency,” adding that both bond and currency markets have adjusted to their respective negative rate environments and continue to function.

NIRP kills two birds, one stone

They appear to be generally supportive of using a negative interest rate policy, noting that it’s common practice for central banks to cut interest rates for the purpose of giving economic activities a boost. When central banks do cut interest rates, the goal is to “hit their inflation targets from underneath,” they add.

Aside from battling a lack of inflation, the HSBC team adds that the debt overhang is another reason recovery has remained weak and is causing “very low” rates of inflation. They sum up by saying that a negative interest rate policy “helps deliver a negative real rate and, while nominal coupons may be bound at zero, negative yields reduce debt over time by haircutting the bondholder at redemption.”

Further, they note that negative real yields are nothing new for the bond market:

negative interest rate policy

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