PMC Weekly Review - February 12, 2016

A Macro View – 2016, The Year of Negative Rates?

On Wednesday of this week Federal Reserve Chair Janet Yellen appeared in front of the House Financial Services Committee to share the Fed’s outlook on the economy and monetary policy. With fears of slowing growth and deflation again taking hold throughout many of the world’s developed economies, investors are listening closely to Yellen’s comments for clues on what the Fed’s actions will be going forward. Although it has been broadly expected that the Fed will continue to raise rates throughout 2016, the frequency and magnitude remain anyone’s guess. However, the Fed doesn’t operate in a vacuum, and that expectation has started to lose steam as other central banks have continued their expansionary policies.

The global economy is entering an environment in which major economies are deciding their interest rate policies are not zero-bound, and negative interest rate policies not only are on the table, but also being enacted as countries take increasingly dovish stances to goad their economies onward. In fact, over one fifth of global GDP is governed by a central bank with negative interest rates, according to the Wall Street Journal. Most recently, despite expectations for real GDP growth to exceed 3% in 2015, Sweden’s central bank, the Riksbank, cut its already-negative main interest rate to negative 35 to 50 basis points, and indicated further decreases are on the table. This follows the surprise move in January by the Bank of Japan (BoJ) to implement a negative interest rate on February 16 of minus 10 basis points on commercial bank deposits that are in excess of required minimums. The BoJ stressed this move was in response to volatile global markets, and that the Japanese economy was continuing on a path of moderate recovery. Both Japan and Sweden’s actions follow other countries’ negative interest rate policies, specifically those of Denmark, Switzerland, and the European Central Bank, which adopted a negative 30 basis point deposit rate in December.

The push of advanced economies into sub-zero territory made Yellen’s comments during Wednesday’s hearing much more meaningful to investors searching for clues as to how the Fed will react to the evolving global environment. The Fed voted to raise the Fed Funds Rate in December, for the first time since 2006, to a target range of 25 to 50 basis points, as a positive response to the continued economic recovery. In the Fed’s view, however, that recovery is starting to appear wobbly. Yellen stated on Wednesday, “Financial conditions in the US have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar.”

Yellen’s statement has led many to speculate on whether the Fed is reconsidering further rate hikes, especially as the negative interest rate policies in other major economies effectively accomplish the Fed’s expected goal of a more hawkish monetary policy. Some may even wonder whether the Fed itself is considering negative interest rates. The Fed recently released the scenarios for stress testing banks in 2016, which incorporate a situation that includes negative yields for short-term Treasury securities. The Fed stated that this was a worst-case scenario, rather than a forecast of future interest rate movements, but it still leaves the door open for investors to question the degree to which the Fed may be rethinking its future moves. In any event, the increasing popularity of negative interest rates raises questions about the Fed’s determination to normalize monetary policy, and will certainly provide fodder for the financial pundits throughout 2016.

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