The central bank experiment with negative interest rates—where governments charge you to buy their debt—is reaching a tipping point. Fierce political backlash is emerging against a policy that hurts savers and small businesses, all of which could have ramifications for U.S. markets.
The bulk of negative-yielding debt is concentrated in Japan and Europe. Globally, the total is now $10.4 trillion, according to Fitch Ratings. In Japan, where politicians are preparing for the next election cycle, negative rates have become a hotbed issue.
The chief policy architect of Japan’s new Democratic Party, Shiori Yamao, just came out publicly against the Bank of Japan. The ruling Liberal Democratic Party had made fiscal and monetary policy front and center in the last election, arguing that the government and central bank had to work together to stimulate the economy.
However, the ruling party’s new platform makes zero mention of monetary policy. While it’s unlikely that the ruling party would reverse course, a change in leadership after the 2018 election would disrupt domestic and global markets.
Ticking time bomb
Europe and Japan have gone about negative rates for different reasons. Individual European countries that do not use the euro are largely trying to weaken their respective currencies, as investors flock to safety.
The European Central Bank, which oversees the euro, introduced negative rates to stimulate growth in the eurozone. Separately, the ECB began buying corporate bonds Wednesday—a move that was announced at a prior policy meeting.
The Bank of Japan also wants to stimulate growth, as well as weaken the yen. The goal is the same: Flood the financial sector with money, hoping that it chases yield into riskier investments.
But if the goal were to coax money into riskier assets, such as stocks, the plan has been a failure so far. European stocks were down 30% at one point after the introduction of negative rates. In Japan, stocks are up only slightly since the beginning of the BOJ’s experiment in January of this year.
Central bankers’ greatest fear
Central bankers have adopted price inflation targets (2% annually in the U.S.) because they are trying to avoid what they perceive as a deflationary trap. In general, lower prices should be good for the consumer. However, central bankers assert that if lower prices are accompanied by asset price deflation, such as lower prices in houses and stocks, wealth is destroyed in a loop that feeds on itself.
This so-called deflationary spiral is the bane of central bankers. It is a consequence of having a highly leveraged financial system pyramided upon government debt. For worse or for better, this is the system that exists.
Negative rates in the U.S.?
Things are slightly different in the U.S. when it comes to negative rates. The Fed is trying to stay the course on a cycle of increasing rates, which is drawing global capital into U.S. markets. (When the BOJ has announced new easing measures, large sums of money have poured into the U.S.) While a June or July rate raise is much less likely now after Friday’s dismal jobs report, investors still expect another rate hike by the end of the year.
Nevertheless, should the economy go south, Fed Chair Janet Yellen has publicly stated that negative rates are on the table. She also admitted this might not be legally possible. However, it is likely being investigated, and further discussion would make it a controversial issue in the U.S., just like it has become in Japan.
It’s not just politicians who are objecting. Many top investors are also against negative rates. According to Allianz Chief Economic Adviser Mohamed El-Erian, negative rates are structurally unsustainable. "We're going to have an impaired financial system," he says. "It means fewer long-term financial services that are credible for society."
By: Jared Blikre (Yahoo).
Photo: CNN.
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