IMF Bells The Cat On Negative Interest Rates And A Need To Ban Cash

Hot off the press – How Can Interest Rates Be Negative? – we get the latest missive from the IMF which confirms precisely what we have been saying.

But the concern remains about the limits to negative interest rate policies so long as cash exists as an alternative.

Here is the article. Read, and weep….

Money has been around for a long time. And we have always paid for using someone else’s money or savings. The charge for doing this is known by many different words, from prayog in ancient Sanskrit to interest in modern English. The oldest known example of an institutionalized, legal interest rate is found in the Laws of Eshnunna, an ancient Babylonian text dating back to about 2000 BC.

For most of history, nominal interest rates—stated rates that borrowers pay on a loan—have been positive, that is, greater than zero. However, consider what happens when the rate of inflation exceeds the return on savings or loans. When inflation is 3 percent, and the interest rate on a loan is 2 percent, the lender’s return after inflation is less than zero. In such a situation, we say the real interest rate—the nominal rate minus the rate of inflation—is negative.

In modern times, central banks have charged a positive nominal interest rate when lending out short-term funds to regulate the business cycle. However, in recent years, an increasing number of central banks have resorted to low-rate policies. Several, including the European Central Bank and the central banks of Denmark, Japan, Sweden, and Switzerland, have started experimenting with negative interest rates —essentially making banks pay to park their excess cash at the central bank. The aim is to encourage banks to lend out those funds instead, thereby countering the weak growth that persisted after the 2008 global financial crisis. For many, the world was turned upside down: Savers would now earn a negative return, while borrowers get paid to borrow money? It is not that simple.

Simply put, interest is the cost of credit or the cost of money. It is the amount a borrower agrees to pay to compensate a lender for using her money and to account for the associated risks. Economic theories underpinning interest rates vary, some pointing to interactions between the supply of savings and the demand for investment and others to the balance between money supply and demand. According to these theories, interest rates must be positive to motivate saving, and investors demand progressively higher interest rates the longer money is borrowed to compensate for the heightened risk involved in tying up their money longer. Hence, under normal circumstances, interest rates would be positive, and the longer the term, the higher the interest rate would have to be. Moreover, to know what an investment effectively yields or what a loan costs, it important to account for inflation, the rate at which money loses value. Expectations of inflation are therefore a key driver of longer-term interest rates.

While there are many different interest rates in financial markets, the policy interest rate set by a country’s central bank provides the key benchmark for borrowing costs in the country’s economy. Central banks vary the policy rate in response to changes in the economic cycle and to steer the country’s economy by influencing many different (mainly short-term) interest rates. Higher policy rates provide incentives for saving, while lower rates motivate consumption and reduce the cost of business investment. A guidepost for central bankers in setting the policy rate is the concept of the neutral rate of interest : the long-term interest rate that is consistent with stable inflation. The neutral interest rate neither stimulates nor restrains economic growth. When interest rates are lower than the neutral rate, monetary policy is expansionary, and when they are higher, it is contractionary.

Today, there is broad agreement that, in many countries, this neutral interest rate has been on a clear downward trend for decades and is probably lower than previously assumed. But the drivers of this decline are not well understood. Some have emphasized the role of factors like long-term demographic trends (especially the aging societies in advanced economies), weak productivity growth, and the shortage of safe assets. Separately, persistently low inflation in advanced economies, often significantly below their targets or long-term averages, appears to have lowered markets’ long-term inflation expectations. The combination of these factors likely explains the striking situation in today’s bond markets: not only have long-term interest rates fallen, but in many countries, they are now negative.

Returning to monetary policy, following the global financial crisis, central banks cut nominal interest rates aggressively, in many cases to zero or close to zero. We call this the zero lower bound, a point below which some believed that interest rates could not go. But monetary policy affects an economy through similar mechanics both above and below zero. Indeed, negative interest rates also give consumers and businesses an incentive to spend or invest money rather than leave it in their bank accounts, where the value would be eroded by inflation. Overall, these aggressively low interest rates have probably helped somewhat, where implemented, in stimulating economic activity, though there remain uncertainties about side effects and risks.

A first concern with negative rates is their potential impact on bank profitability. Banks perform a key function by matching savings to useful projects that generate a high rate of return. In turn, they earn a spread, the difference between what they pay savers (depositors) and what they charge on the loans they make. When central banks lower their policy rates, the general tendency is for this spread to be reduced, as overall lending and longer-term interest rates tend to fall. When rates go below zero, banks may be reluctant to pass on the negative interest rates to their depositors by charging fees on their savings for fear that they will withdraw their deposits. If banks refrain from negative rates on deposits, this could in principle turn the lending spread negative, because the return on a loan would not cover the cost of holding deposits. This could in turn lower bank profitability and undermine financial system stability.

A second concern with negative interest rates on bank deposits is that they would give savers an incentive to switch out of deposits into holding cash. After all, it is not possible to reduce cash’s face value (though some have proposed getting rid of cash altogether to make deeply negative rates feasible when needed). Hence there has been a concern that negative rates could reach a tipping point beyond which savers would flood out of banks and park their money in cash outside the banking system. We don’t know for sure where such an effective lower bound on interest rates is. In some scenarios, going below this lower bound could undermine financial system liquidity and stability.

In practice, banks can charge other fees to recoup costs, and rates have not gotten negative enough for banks to try to pass on negative rates to small depositors (larger depositors have accepted some negative rates for the convenience of holding money in banks). But the concern remains about the limits to negative interest rate policies so long as cash exists as an alternative.

Overall, a low neutral rate implies that short-term interest rates could more frequently hit the zero lower bound and remain there for extended periods of time. As this occurs, central banks may increasingly need to resort to what were previously thought of as unconventional policies, including negative policy interest rates.

No, central banks are taking us down a blind alley!

Retail turnover falls 0.3 per cent in January

Australian retail turnover fell 0.3 per cent in January 2020, seasonally adjusted, according to the latest Australian Bureau of Statistics (ABS) Retail Trade figures. This follows a fall of 0.7 per cent in December 2019.

The trend estimate rose 0.1% in January 2020. This follows a rise of 0.1% in December 2019, and a rise of 0.2% in November 2019.

The seasonally adjusted estimate fell 0.3% in January 2020. This follows a fall of 0.7% in December 2019, and a rise of 1.0% in November 2019.

In trend terms, Australian turnover rose 2.3% in January 2020 compared with January 2019.

Compared to January 2019, the trend estimate rose 2.3 per cent.

The following industries rose in trend terms in January 2020: Food retailing (0.2%), Cafes, restaurants and takeaway food services (0.1%), and Clothing, footwear and personal accessory retailing (0.1%). Household goods retailing (0.0%), and Other retailing (0.0%) were relatively unchanged. Department stores (-0.3%) fell in trend terms in January 2020.

The following states and territories rose in trend terms in January 2020: Queensland (0.3%), Victoria (0.2%), Tasmania (0.7%), and the Northern Territory (0.1%). South Australia (0.0%), and Western Australia (0.0%) were relatively unchanged. New South Wales (-0.1%), and the Australian Capital Territory (-0.2%) fell in trend terms in January 2020.

“Bushfires in January negatively impacted a range of retail businesses across a variety of industries” said Ben James, Director of Quarterly Economy Wide Surveys. “Retailers reported a range of impacts that reduced customer numbers, including interruptions to trading hours and tourism.”

There were falls for household goods retailing (-1.1 per cent), department stores (-2.2 per cent), clothing, footwear and personal accessory retailing (-1.1 per cent), cafes, restaurants and takeaway food services (-0.3 per cent), and other retailing (-0.1 per cent). These falls were partially offset by a rise in food retailing (0.4 per cent).

In seasonally adjusted terms, there were falls in Western Australia (-1.1 per cent), Victoria (-0.2 per cent), the Australian Capital Territory (-2.3 per cent), New South Wales (-0.1 per cent), Queensland (-0.1 per cent), Tasmania (-0.5 per cent), and the Northern Territory (-0.5 per cent). South Australia (0.1 per cent) rose in seasonally adjusted terms in January 2020.

Online retail turnover contributed 6.3 per cent to total retail turnover in original terms in January 2020. In January 2019, online retail turnover contributed 5.6 per cent to total retail.

The GDP Per Capita Conundrum

We had the latest national accounts to end of December 2019 this week. The ABS advised that:

The Australian economy grew 0.5 per cent in seasonally adjusted chain volume terms in the December quarter 2019 and 2.2 per cent through the year, according to figures released by the Australian Bureau of Statistics (ABS).

Chief Economist for the ABS, Bruce Hockman, said: “The economy has continued to grow and picked up through the year, however the rate of growth remains below the long run average.”

Domestic demand remained subdued with 0.1 per cent growth in the December quarter. A pick up in household discretionary spending and continued increases in the provision of government services was dampened by falls in dwelling and private business investment.

Falls in dwelling investment continued, declining 3.4 per cent during the quarter, the sixth consecutive fall. This fall was consistent with the decline in construction industry value added, falling 2.3 per cent. The housing market recovery is evident in the increase in ownership transfer costs, rising 12.3 per cent during the quarter to be up 6.5 per cent through the year.

Household income remained steady with compensation of employees recording its twelfth consecutive rise, increasing 1.0 per cent during the quarter. This reflects a rise in the number of wage and salary earners as well as a steady increase in the wage rate. Non-life insurance claims contributed to household income reflecting increased claims attributed to natural disaster occurrences in the quarter. The household saving to income ratio was 3.6 per cent, driven by the subdued consumption coupled with steady increases in wages and a boost in insurance claims.

The Mining industry provided additional strength to the economy, with growth in production volumes of 1.6 per cent, strengthening through the year to 7.3 per cent. This was reflected in the growth in mining exports and inventories.

Falling prices for key export commodities impacted the terms of trade in the December quarter, which fell 5.3 per cent. This reduced nominal GDP, which fell 0.3 per cent, as lower coal, iron ore and gas prices contributed to more subdued company profits. Mining profits declined 2.6 per cent for the quarter.

Real net national disposable income declined 0.9 per cent. “Fluctuations in commodity prices have significant effects on the Australian economy in terms of export revenues and real income,” added Mr Hockman.

But the real question is, does the GDP really tell us anything useful? I discuss the GDP question with American in OZ Salvatore Babones, Associate Professor, University of Sydney.

Mortgage Stress Still Climbed In February

The official story is that lower interest rates are translating to reduced financial stress in the community. The true story, as revealed in the latest edition of our mortgage stress analysis is that more households are up against it, with a record 32.9% of mortgages households wrestling with cash flow issues. This translates to 1.08 million households in stress, and more than 82,000 risking default in the months ahead.

Many households are chasing their tails, in that while mortgage repayments are dropping – for some, rising living costs and flat real incomes are compounding their financial pressures. There was a sharp downturn in take home pay, thanks to bushfires and the virus is beginning to hit businesses, (who in turn are less able to pay and retain staff, especially those on “flexible” contracts).

Across our master household segments, the highest proportion of households under pressure are “Young Growing Families”, which includes many recent first time buyers, “Battling Urban” – those older households living in the main urban corridors, and “Disadvantaged Fringe” households, those living in the often new fringe developments are also at the top of the list. That said, stress takes no prisoners, in that even some wealthy households, and more mature families are also under pressure.

Across the states, the highest proportion of households are in Tasmania, where the recent run up in prices, against high costs and low wages is a nasty cocktail. As yet though defaults remain low here. Western Australia has a significantly higher level of defaults, because the financial pressures have been running for years. The largest counts of stressed households are located in Victoria and New South Wales, with Queensland also seeing a further rise. Defaults are expected to rise again.

Across the regions, there are considerable variations, with a significant spike in some areas following the recent bushfires.

The top 20 post codes reveals that WA post code 6065 which includes Tapping and Hocking tops the list this month, with more than 7,000 households impacted. Liverpool, 2170, in New South Wales, Narre Warren 3805 in Victoria and Toowoomba 4350 in Queensland are all at the top of the list. The common theme here is significant and recent higher density development, large mortgages and over priced real estate (and supported by insufficient infrastructure).

As always we remind households that maintaining a cash flow record is an essential tool to managing a household budget – there are good tools available on ASIC’s Money Smart Web Site. Less than half of the households surveyed know their financial status. Careful prioritisation, and repaying higher interest debts first often makes the most sense, especially when wages growth will remain sluggish (and before the economic impact of the virus really hits). Finally, refinancing may provide short term relief, but without a change in behaviour this will not be long lasting.

We will update our models again next month.

Federal Reserve Board Approves Simplified Capital Rules for Large Banks

The US Federal Reserve Board on Wednesday approved a rule to simplify its capital rules for large banks, preserving the strong capital requirements already in place.

The “stress capital buffer,” or SCB, integrates the Board’s stress test results with its non-stress capital requirements. As a result, required capital levels for each firm would more closely match its risk profile and likely losses as measured via the Board’s stress tests. The rule is broadly similar to the proposal from April 2018, with a few changes in response to comments.

“The stress capital buffer materially simplifies the post-crisis capital framework for banks, while maintaining the strong capital requirements that are the hallmark of the framework,” Vice Chair for Supervision Randal K. Quarles said.

The SCB uses the results from the Board’s supervisory stress tests, which are one component of the annual Comprehensive Capital Analysis and Review (CCAR), to help determine each firm’s capital requirements for the coming year. By combining the Board’s stress tests—which project the capital needs of each firm under adverse economic conditions—with the Board’s non-stress capital requirements, large banks will now be subject to a single, forward-looking, and risk-sensitive capital framework. The simplification would result in banks needing to meet eight capital requirements, instead of the current 13.

The SCB framework preserves the strong capital requirements established after the financial crisis. In particular, the changes would increase capital requirements for the largest and most complex banks and decrease requirements for less complex banks. Based on stress test data from 2013 to 2019, common equity tier 1 capital requirements would increase by $11 billion in aggregate, a 1 percent increase from current capital requirements. A firm’s SCB will vary in size throughout the economic cycle depending on several factors, including the firm’s risks.

To reduce the incentive for firms to take on risk and further simplify the framework, the final rule does not include a stress leverage buffer as proposed. All banks would continue to be subject to ongoing, non-stress leverage requirements.

Large banks have substantially increased their capital since the first round of stress tests in 2009. The common equity capital ratio of the banks in the 2019 CCAR has more than doubled from 4.9 percent in the first quarter of 2009 to 12.2 percent in the fourth quarter of 2019, with total capital doubling to more than $1 trillion.

Also on Wednesday, the Board released the instructions for the 2020 CCAR cycle. The instructions confirm that 34 banks will participate in this year’s test. CCAR consists of both the stress tests that assess firms’ capital needs under stress and, for the largest and most complex banks, a qualitative evaluation of the practices these firms use to determine their capital needs in normal times and under stress. Results will be released by June 30.

Support package gains shape as GDP turning point swamped

The good news is our economy was performing better than had been thought in the lead-up to the bushfires and coronavirus. Via The Conversation.

Updated figures in Wednesday’s national accounts show the economy grew 0.6% in the three months to September, rather than the 0.4% previously reported, and a healthier-than-expected 0.5% in the three months to December.

Combined, these figures pushed annual economic growth up above 2% to 2.2% for the first time in a year in which it had been below 2% for the longest period since the global financial crisis.

Annual GDP growth

Through-the-year economic growth by quarter. Source: ABS 5206.0

Not to put too fine a point on it, it looks as if we were actually experiencing the the “gentle turning point” repeatedly promised by Reserve Bank Governor Philip Lowe.

As Lowe put it during the second half of last year:

After having been through a soft patch, a gentle turning point has been reached. While we are not expecting a return to strong economic growth in the near term, we are expecting growth to pick up.

The figures show the economy began (gently) picking up after the Reserve Bank began cutting rates in June. Counting this week’s latest interest rate cut, it has cut four times.

But the coronavirus and the bushfires have consigned the turning point to history.

Negative growth now possible

Not for a minute does Treasurer Josh Frydenberg believe the economy continued to improve this quarter, the March quarter.

Reminded that the support package promised by the prime minister will come too late for the three months to March, and reminded that many businesses haren’t been able to trade much, Frydenberg was asked to assess the risk the economy might now be going backwards, a state of affairs that if it continued long enough would be a recession.

He replied that the Treasury believes the bushfires alone will shave 0.2 points from growth in the March quarter. Added to that will be the risk from the spread of the coronavirus, which he believes will be “substantial”.

Tonight (Wednesday) Frydenberg and Treasury officials will take part in a phone hookup with other members of the International Monetary Fund to discuss developments including interest rate cuts in both Australia and the United States.

Treasury update on Thursday

The Treasury will finalise its estimate of the impact of the coronavirus on March-quarter GDP later in the evening and report it to a Senate estimates hearing beginning at 9am Thursday.

It means we will know the likely impact at about the same time as the treasurer.

To support retirees hurt by four near-consecutive rate cuts, the treasurer is considering cutting the deeming rate – the rate investments are deemed to have earned for the purposes of the pension income test. It’ll be the second deeming rate cut in the space of a year and will make it easier for retirees earning very little to remain on the pension.

The focus of the support package will business investment, which slid an unexpected 1.1% in the final three months of the year and 3.4% over the course of the year in defiance of budget forecasts it would climb.

Standard of living slipping

Although not ruling out support for householders, Frydenberg said mortgage holders had done well out of the past four rate cuts. Households with A$400,000 mortgages could soon be paying $3,000 less per year than they had in June.

Living standards, as measured by the Reserve Bank’s preferred measure, real net national disposable income per capita, went backwards in the December quarter, slipping 1.3%. Over the year, it climbed just 1.2%.

Household spending recovered somewhat, climbing 0.4% in real terms in the December quarter after inching ahead only 0.1% in the September quarter.

Throughout the year to December, real household spending grew 1.2% at a time when Australia’s population grew 1.5%. This means the consumption of goods and services per person went backwards.

Government spending provided substantial support. Over the year to December public spending on infrastructure grew 4.1% in real terms.

Deputy Prime Minister Michael McCormack said on Wednesday he would try and boost that by asking state and local governments to bring forward whatever projects they could, to start work in the next three to six months.

Recurrent government spending grew 5%.

Author: Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

Rate Cuts Don’t Cure Viruses

As expected the RBA cut the cash rate to 0.5% “the Board took this decision to support the economy as it responds to the global coronavirus outbreak”.

RBA Cuts, As Expected

All the major banks passed on the cut in full (thanks to severe political pressure), though gritted teeth. The profit pressure at the banks just went up a notch, on our modelling, a potential fall of more than 3%, though for some regionals perhaps double that. Players like Suncorp also passed on the cut.

The Government has said there will be a targetted package to assist businesses soon, and before the May budget. The savings deeming rate is now completely out of wack with even the very best deposit rates available, so pensioners, those on Government support and welfare are being hit by the gap. The deeming rate for singles is currently 3.0% for assets over $51,200 and 1.0% for those under that threshold. One way the Government is “balancing” the budget

Overnight the FED cut, in an expected “unexpected” drop of 50 basis points. This was the first time the Fed had cut by more than 25 basis points since 2008 and the reduction marks a stark shift for Powell and his colleagues. They had previously projected no change in rates during 2020, remaining on the sidelines during the election year, after lowering their benchmark three times in 2019. They of course rejected any political influence despite Trump’s consistent pressure to drop rates.

Its become very clear that central bankers are worried not only about the economic impact of COVID-19 but also the losses in the stock market.

The Fed said the coronavirus outbreak had disrupted economies in many countries and these measures will weigh on activity for some time. The magnitude and persistence of the impact is uncertain but the risks to their outlook changed enough to justify a move to support the economy. He added that there will be more action by each G7 nation along with the possibility of formal coordination. In other words, more easing is on the way from other central banks including the Fed if the sell-off in stocks deepens and the global slowdown worsens. This was aimed to restore confidence in the market, it did not.

The OECD indicated that economic growth could fall to as low as 1.5% for this year. The Fed’s decision could trigger a wave of easing from other central banks around the world although those in the euro-area and Japan have less scope to follow with rates already in negative territory.

The G7’s issued a statement that was to the point:

We, G7 Finance Ministers and Central Bank Governors, are closely monitoring the spread of the coronavirus disease 2019 (COVID-19) and its impact on markets and economic conditions.

Given the potential impacts of COVID-19 on global growth, we reaffirm our commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.  Alongside strengthening efforts to expand health services, G7 finance ministers are ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy during this phase.  G7 central banks will continue to fulfill their mandates, thus supporting price stability and economic growth while maintaining the resilience of the financial system.

We welcome that the International Monetary Fund, the World Bank, and other international financial institutions stand ready to help member countries address the human tragedy and economic challenge posed by COVID-19 through the use of their available instruments to the fullest extent possible.

But the point is, no rate cut, or government stimulus can cure the virus, which continues to spread with person to person transmission on the rise.

The latest WHO update says eight new Member States (Andorra, Jordan, Latvia, Morocco, Portugal, Saudi Arabia, Senegal, and Tunisia) reported cases of COVID-19 in the past 24 hours. Globally 90,870 cases have been confirmed (1,922 new), with China 80,304 confirmed (130 new) and 2,946 deaths (31 new). Outside of China 10,566 cases are confirmed (1,792 new) in 72 countries (8 new) with 166 deaths (38 new).

The flow on effects in terms of reduced commerce is significant, with more businesses unable to source raw materials or distribute good. Across transport and tourism, and education the impacts are immediate, but other sectors are following. Hence the expectation of slowing growth.

The question becomes, at what point do businesses cease to trade, or pay their employees, and to what extent will households also hunker down (many were already).

The US markets reacted badly to the FED’s move, with the Dow down close to 3%.

The ASX was also down in early trading.

The supply side consequences of the virus, could well flow on the credit markets, and in this case lower interest rates – other than as a confidence signal will not help.

Central bank tools are not going to cure the virus, and lower rates and more QE liquidity might well make the situation worse. Fiscal responses can provide a little more support, perhaps, though Governments seem reluctant to play that card hard.

We are in uncharted territory, and I do not think Central Banks can save us this time.