Fed Tells the Banks to Prepare for Negative Rates http://www.cnbc.com/2016/02/09/from-zirp-to-nirp-whats-the-feds-next-move.html Negative interest rates in the U.S. may seem like a far-fetched idea, but the Federal Reserve is telling banks to prepare, just in case. For the first time ever, the governing agency and U.S. central bank is requiring banks to include, in a round of stress tests commencing this year, to prepare for the possibility of negatively yielding Treasury rates. The scenario is purely hypothetical and not a forecast, according to a Jan. 28 Fed news release . However, the development is part of a larger scenario of a world where zero rates are morphing into negative rates. This is how beggar-thy-neighbor monetary policies work, and perhaps why they ultimately fail. One nation mired in an economic slump decides that the best way out is to devalue its currency, cheapening its exports and thus making them more attractive in countries that have higher-yielding currencies and, consequently, more buying power. Seeing the success that country has, another seeks to emulate. And then another. And another. And another. In order to stay ahead of the game, central banks keep devaluing until there's nothing left, tangibly at least, to devalue, and negative interest rates come into play. Pretty soon you have nearly a third of all sovereign debt holding negative yields. In turn, what seemed like a powerful tool to stimulate lending and export-led economic growth becomes a toothless tiger that global central banks continue to deploy, the latest being in Japan. Suddenly, zero interest rate policy, or ZIRP, has morphed into negative interest rate policy, or NIRP. This is no dystopian hypothetical. This is what central banking has become in a global economy beset by meager growth. Worries are growing that the Federal Reserve soon could bring NIRP to U.S. rates. Japan went to NIRP last week, and the yield on the 10-year Japanese government bond went negative overnight Monday for the first time ever. "It appears that NIRP is becoming the main policy tool for a number of major central banks as they battle falling inflation, rising currencies and economic weakness," Jeffrey Kleintop, chief global investment strategist at Charles Schwab, said in an analysis. "The effectiveness of slightly negative interest rates is far from assured, and increasingly negative interest rates may not just weigh more heavily on the stock market, but on drivers of economic growth as well." Indeed, ZIRP seemed to pull stock markets higher, but the spreading of NIRP has coincided with a sharp global equity decline, particularly in financial stocks. The Fed's chances of going to NIRP seem, at least now, to be slim. Its policymaking arm, the Federal Open Market Committee, just hiked its interest target in December for the first time in nine years, so changing now would seem like a stunning retreat. Yet several high-ranking officials recently have paid at least lip service to the idea. In a speech last week, Fed Vice Chair Stanley Fischer said Europe's experiment with negative rates is "working better than I expected," raising speculation that should things deteriorate the U.S. central bank would consider going negative. Negative rates in the U.S. would begin with the interest paid on excess reserves that banks store at the Fed, a number currently at $2.15 trillion that earns 0.5 percent interest. The idea would be to charge banks to store reserves, making the cost prohibitive to let the money lie fallow there and push it into the broader economy through lending, thus stimulating growth. It's an idea that works in theory and, for a period, worked in practice for the four European governments that tried it. However, there are problems. One is that banks would need to make up that lost revenue someplace and instead of lending could amp up fees and rates. Another is that the more countries that join in, the less effective one nation's low or negative interest rates are. Finally, in a problem that would be especially acute in the U.S., negative rates could send a jolt through the $2.75 trillion money market space and, some fear, lead to a "break the buck" scenario that occurred during the financial crisis when one large money market fund couldn't return par on its investments. "Things would have to get truly desperate to go to negative rates," Kim Rupert, managing director of global fixed income at Action Economics, said in an interview. "Our money markets are obviously the biggest in the world and have a lot of commitments tied to them and the liquidity for a lot of our economy. Jeopardizing the money markets would be too dramatic an effect for the Fed to consider going in that direction." Still, the futures market is indicating that if the Fed doesn't move to outright NIRP, the chances for an aggressive rate-hiking policy ahead, as indicated after the December rate rise, are nil. The CME's FedWatch tool briefly went into a kind of backwardation Monday, indicating a -2 percent chance for a rate hike at the March FOMC meeting (the probability quickly moved back to plus-2 percent). The tool's farthest date, February 2017, indicates just a 15 percent chance of an increase, the implication being no moves in 2016 even though the Fed's "dot plot" of official projections points to four hikes this year. The actual fed fund futures curve does not indicate a rate rise fully priced in until December 2017. Michael Darda, chief economist and market strategist at MKM Partners, thinks the Fed would be wise to heed market signals and pay less attention to its models, including the Phillips curve guideline, that indicate a faster tightening cycle. The Fed's moves to end ZIRP andquantitative easing, along with China's decision to peg the yuan to the dollar, "has translated into a tightening world monetary policy" similar to what happened in the 1930s. "The current risk is that policymakers are overly optimistic about the business cycle carrying on in a way that allows inflation to return to its target," Darda said in a note to clients. "Given the U.S. dollar's reserve currency status and the PBOC's quasi peg, global monetary conditions have tightened sharply, causing world nominal growth expectations to weaken. There are some disturbing parallels to 1937, in our view, that should continue to be monitored closely." What the Fed will need to weigh ultimately is whether going to NIRP is worth risking its credibility, and whether low or negative rates will have any discernible effect on financial conditions. Bank stocks already are in a bear market, the economy is slowing and damage from the energy sector clearly is seeping into other parts of the economy. Moving to NIRP now might be regarded as a panic reaction that actually could make things worse. "I don't think there are high odds that we're going to fall into a recession this year, but what if we did?" said Jim Paulsen chief investment strategist at Wells Capital Management. "If we went into recession now, when you had a zero short rate effectively and a sub-2 percent 10-year Treasury and a $4 trillion Fed balance sheet to spin out and a debt-to-GDP ratio that's 100 percent on sovereign government debt, I think there would be a fair amount of panic in the cultural mindset because there would be a sense that we went into recession and there's nothing anyone could do about it," he added. "That's a dangerous situation to put yourself in."
NIRP FACTS: 1) Negative rates will negatively impact government bond markets. It will drive money into other venues - especially the equity markets. 2) To work, NIRP will have to see physical currency replaced with digital to prevent hoarding. And should the screen go dark - you will have no funds. 3) If your bank account is hacked, or frozen for whatever reason, you will be flat broke with no reserve funds. To stay alive until the situation is corrected, you will have to have something to barter, such as gold. 4) Pension funds and insurance investment portfolios will not be able to honor obligations and will enter some form of bankruptcy. 5) Government control over the individual will increase markedly, and personal freedom will be strictly limited. 6) NIRP will severely impact global trade, resulting in lower worldwide gdp growth. 7) The safest place to keep one's funds will be equities in America's largest corporations, especially those which pay dividends.
Pension funds are getting hammered by zirp. Nirp would only make it worse: ======= Pension Funds See 20% Spike In Deficit (AP) Oregon Treasurer and Portland mayoral candidate Ted Wheeler issued a statement last week noting that the state pension fund’s investment returns were 2.1% in 2015. That beat the Standard & Poor’s 500 index and topped the performance of 88% of comparable institutional investment funds. What Wheeler’s statement didn’t mention was that investment returns for the year still fell 5.6 percentage points below the system’s 7.75% assumed rate of return for 2015. That’s terrible news for public employers and taxpayers. It means the pension system’s unfunded liability just increased by another 20% — growing from $18 billion at the end of 2014 to between $21 and $22 billion a year later. That will put renewed upward pressure on payments the system’s 925 public-sector employers are required to make. Public employers had already been warned to expect maximum increases over the next six years, which would take their pension fund contribution rates from an average of about 18% of payroll to nearly 30%, redirecting billions of dollars out of public coffers and into the retirement system. In reality, those “maximum” increases could be a lot bigger. Milliman Inc., the actuary for the Public Employees Retirement System, told board members at their regular meeting Feb. 5 that the pension fund now has 71 to 72 cents in assets for every $1 in liabilities. That’s an average number across the entire system. Some individual employers’ accounts, including the system’s school district rate pool, are flirting with the 70% threshold that triggers larger maximum rate increases. Here’s how it works: To prevent rate spikes, PERS limits the biennial change in employers’ payments to 20% of their existing rate. For example, if an employer is required to make contributions equal to 20% of payroll, the rate increase is “collared” to 20% of that number, or a 4 percentage-point increase. That 20% increase is what employers have been warned to expect every other year for the next six years. But when an employer’s funded status falls below 70%, that collar begins to widen on a sliding scale — up to a maximum of 40%.
As the rate of return on risk free assets goes below zero and the rate of return on risk assets creeps closer to zero, it makes investments at best a marginal proposition and at worst a losing proposition. Savers have already found out the hard way what life is like when there's no return on money. Workers, on the other hand, are still receiving their paychecks. But is there really a great economic span between them? Is the real economy still actually receiving a return that justifies paying all those millions of wage earners? The rate of return in financial mkts and the rate of return in the real economy should converge at some point. Some of the difference may be explained right now as nothing more than accounting fiction. Which means the rate of return in the real economy may head toward very little return on investment. So what does that mean for all those millions of workers who are still making a living while retirees are getting the shaft. To me, it means sh*tz bout to get reel for workers.
And maybe some select muni bond holders. That's what I take away from this whole thread. Big government can print their way out. Not so for states and cities. I also wonder if we'll see a revolt by the municipal employees stuck paying more and more for the previously retired and disabled.
So, now that we've seen eye to eye on this point, would employment be better served by monetary or fiscal policy?
Well, in my opinion fiscal policy, driven by legislation, in combination with local and world events largely drives monetary policy. In other words my view is that the central banks, in Western countries anyway, do not so much lead as react. We have seen how inattention to their bank regulatory role led to a calamity that can largely be laid at the feet of an insouciant Fed. The one body that had both the knowledge and the authority to reign in Bank and Mortgage excesses, but nevertheless did nothing, was the Fed. So here we have a prime example of a central bank making a big mistake. Of course we must acknowledge that their role was made more difficult by allowing insurance and banking to merge. That never should have happened. And who were the advocates, besides of course big banking and insurance interests, and the husband of the CFTC Chair? It was our former Treasury Secretary and former Goldman Chairman, Robert Rubin, and Alan Greenspan. In retrospect, Greenspan made a big mistake not to launch strong objection to the deregulation that led to so much trouble. There were a few who predicted the precise outcome, Daschle was one, but they were powerless to stop the Financial Modernization Act from being inserted by Gramm and Bliley to the 'must sign' Omnibus Spending Bill. It was philosophically impossible, of course, for Greenspan to do other than support the FMA. To do otherwise would have run counter to every laissez faire fiber in his body. We do what we are driven to do! And sometimes it is something very, very bad. I have to be careful not to get carried away in my critique of Greenspan. I knew he was a bad Chairman well before we got as far as the Crisis. I could write an entire book about him. The really sad thing is there are still today, among the Republican Party Establishment, advocates for supply-side- trickle down economics. This, years after those economic ideas were shown to fail miserably in reaching the stated goals. The chief accomplishment of the supply-siders has been to return us back to early twentieth century income distribution and the inevitable, milk-toast economy that follows. How could it be otherwise?! We've left all the capital in the hands of a tiny fraction of the population!!! It's is bad for the poor; it's disastrous for the middle class; and it's bad for the wealthy too! No one wins under trickle down economics. I am a firm defender of central banks, as you well know. To me the mistakes point out the necessity of finding very knowledgeable, highly competent public servants to run them. Greenspan had only a masters degree in economics when he was appointed by Nixon. He had some prior professional experience as an economist, but little in the kind of experience that would have made him a first rate central banker. He had worked in Nixon's campaign and helped Nixon get elected, and he talked a good game, so Nixon rewarded him. We learned a lesson! Avoid ideologues when selecting a Fed Chair! The present Fed Chair, and her immediate predecessor, are both exceedingly competent. You will not see another Central Bank disaster under the current watch. I assure you of that.