In the famous 1939 movie Gone with the Wind, Scarlet O’Hara (Vivien Leigh) delivers this poignant entreaty to Rhett Butler (Clark Gable): “Where shall I go? What shall I do?”
Rhett counters with the retort, “Frankly, my dear, I don’t give a damn.” A blockbuster line delivered in just seconds, it has endured for decades. Rhett goes on his way, and Scarlett is left with only the threadbare hope that he will return to her. Here’s a 2-½–minute YouTube of the scene: https://www.youtube.com/embed/GQ5ICXMC4xY .
Markets don’t give a damn about impeachment. The third-ever passage of an impeachment article by the House of Representatives has dominated the news flow, but it has been virtually ignored by the markets. Stocks were little changed. The Brexit outlook has had a bigger market impact in Europe and in currency exchange rate futures involving the British pound. Most bond market interest rates were hardly affected.
Most central banks around the world remain on hold. The Fed has continued to expand year-end liquidity, as it is determined not to repeat the September repo spike. The central banks of the European Union, Japan, Canada, and others have stayed their course. Only Sweden has stood out as it has rejected any further negative interest rates and raised its policy rate back up to zero. We applaud the Riksbank and its governor, Stefan Ingves.
A word of digression is needed here about Sweden’s Riksbank. This was the world’s first central bank: It opened its doors in 1668. Although the bank was private, it was the Swedish king who selected its management. See https://en.wikipedia.org/wiki/Sveriges_Riksbank#History.
Governor Ingves is one of the most respected and skilled central bankers in the world. I’ve had the privilege of meeting him and conversing publicly with him during a central banking panel at a Global Interdependence Center conference in Helsinki. He was not comfortable with negative rates, a position that I recall clearly.
Sweden’s was the first central bank to cut its policy interest rate below zero. That was in 2009. There was a reason. Ingves and his colleagues managed monetary policy with a clear commitment to a corridor system. The principle of a corridor is to have a floor and a ceiling or top rate set by the central bank and then let market forces drive the pricing of the policy rate in between the floor and the ceiling. That enables the central bankers to observe the pressures within the corridor and obtain early warning signs of trouble so they may prepare and act quickly. The corridor principle was applied for decades, until the financial crisis. Once interest rates were taken to zero (which was considered the lower bound at the time) central banks started to use quantitative easing (balance sheet enlargement), since the corridor was no longer effective.
In Sweden’s case, Governor Ingves didn’t want to give up the corridor. He is to be applauded for that dedication to discipline. He faced a problem when all the interest rates in countries around him were at zero and his policy rate was also going to zero. The only way he could maintain the corridor and still center the policy rate at zero was to take the lower bound below zero. Hence the -0.25% lower bound was set by Sweden in 2009, and the negative interest rate policy (NIRP) was born. Little did anyone suspect what the next decade would bring.
In 2014, the newly installed ECB president, Mario Draghi, started an experiment with NIRP and seriously expanded the ECB balance sheet while rolling out increasingly negative rates. Others in Europe, including Switzerland, Sweden, and Denmark, had no choice but to match or go under the ECB’s negative rates in self-defense. Those countries are still paying the price for Draghi’s approach to policy. The Swedish low was about -1.25% for a 3-month government note, on November 18, 2017. That was the lowest point of NIRP and lowest policy rate recorded among the four European currencies (those of the Eurozone, Sweden, Denmark, and Switzerland).
Sweden is back up to zero. My fishing camper friend Peter Boockvar summed it up nicely in his morning note entitled “Is this the end of NIRP?”:
“… the Riksbank officially said good riddance to 5 years of negative interest rate policy, the first central bank who had taken the plunge of slapping a tax on its banking system expecting it to be stimulative that has decided that enough is enough. They said ‘Inflation has been close to the Riksbank's target of 2% since the start of 2017, and the Riksbank assesses that conditions are good for inflation to remain close to the target going forward.’ They still believe that NIRP worked, have not ruled out using it again and will stick to zero for a while however. I believe the only thing it worked to do, and successfully, was dramatically compress interest rates, their yield curve and the profits of their banks, the supposed transmission mechanism of the policy.”
(paywall: https://boockreport.com/is-this-the-beginning-of-the-end-of-nirp/)
With Draghi gone and new ECB president, Christine Lagarde, ordering the staff and board of the ECB to conduct a strategic review, we may be seeing the beginning of the ending of NIRP in the eurozone. Total global negative-rate debt that peaked at $17 trillion last summer is now down to under $12 trillion and falling. In our view, ending NIRP would be a good thing. It would benefit savers and encourage capex deployment and, therefore, economic growth.
It would also help financial markets restore traditional pricing models and risk measures. Remember that an asset price discounted at a negative interest rate leads to a price of infinity, which we know is impossible. NIRP encourages bubbles. And the influence of NIRP is global, thus a negative rate in Europe can encourage bubble pricing in other jurisdictions, including the US.
Markets rallied after the impeachment vote. Clearly, impeachment by the House is viewed by markets as a political item with no real market-moving consequences.
Markets also seem to be liking the restoration of “normalcy” in the central banking arena. And markets like the Fed’s commitment to do “whatever it takes” to avoid another repo spike like the one we saw in September (see: https://www.cumber.com/repo-market-monetary-policy-liquidity-virtual-event/).
We end the year with this picture of a gradual movement to normalcy by the world’s central banks, while they remain committed to ample liquidity to avoid any shocks.
Let’s close with an Italian language lesson that my friend Vincenzo Sciarretta helped me with. Vince wrote:
“David, Draghi's speech was in English, I guess on July 26, 2012, at the Global Investment Conference in London.
“He said ‘Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And, believe me, it will be enough.’
“By and large, in Italian it would be:
Nell'ambito del nostro mandato, la BCE e' pronta a fare tutto il necessario per preservare l'euro. E, credetemi, sarà abbastanza.
“’Whatever it takes’ is more or less ‘tutto cio' che serve’.
“But the original was in English!”
We thank Vince and wish him and his family well for the coming new year.
As for NIRP and its departure, we shall revert to the opening remark by Clark Gable: “Frankly, my dear, I don’t give a damn.”
My earlier piece on NIRP, “NIRP, Lagarde, Trump, Dickens & Holidays,” is available here: https://www.cumber.com/cumberland-advisors-market-commentary-nirp-lagarde-trump-dickens-holidays/.
Also, John Authers of Bloomberg’s Points of Return quoted extensively from this commentary. Those who are already subscribers to Points of Return will find his piece here: “We're Sensing Some Negativity About Sub-Zero Rates,” https://www.bloomberg.com/opinion/articles/2019-11-25/negative-interest-rates-are-hurting-financial-markets-k3dyrr8q.
And a free subscription to Points of Return is available here: http://link.mail.bloombergbusiness.com/join/4wm/opinion-authers-signup&hash=b9b2681361bede0e1069ca238efb1ec2
Happy holidays and safe New Year’s wishes to all. Let 2020 be the year of NIRP’s demise. That is a good New Year’s Eve resolution.
David R. Kotok
Chairman and Chief Investment Officer
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