The Race to Zero Interest Rates
With the global economic downturn in full swing, one of the burning questions on everyone’s minds is who will be the first central bank to take interest rates to zero, and how close will everyone else get?
We are in a global easing cycle, and the varying aggressiveness of central banks around the world means that any country could be the first to see zero interest rates.
We expect December to be another active month for the foreign exchange market as central banks around the world take their interest rates to historically significant levels. There are 4 central banks with monetary policy decisions in the first week of December and all 4 are expected to cut interest rates. The closest to zero is the Bank of Japan, but having been there before, they are reluctant to revisit those levels. The US Federal Reserve and the Swiss National Bank have the second lowest interest rates. Both central banks are expected to continue to ease, but the Fed has been far more open about going to zero interest rates than the SNB. Realistically, Japan and the US will probably be the only ones to take rates all the way down to zero. Switzerland should be left with the second lowest interest rate when the dust settles followed by the Bank of England.
What Happens After Zero?
When a central bank runs out of room to cut interest rates, it resorts to Quantitative Easing. This term was coined by the Bank of Japan in 2001 when interest rates were already at zero and the central bank stopped targeting the overnight call rate and turned to targeting a current account level. Their goal was to flood the Japanese financial system with liquidity by buying trillions of yen of financial securities including asset-backed instruments and equities.
It can be argued that the US has already engaged in Quantitative Easing as the government has recently announced plans to spend $800 billion to unfreeze the consumer and mortgage market. They have agreed to buy mortgage backed securities backed by government sponsored entities and could accelerate that if interest rates hit zero. Excess reserves have also increased significantly, driving the effective fed funds rate well below 0.5 percent. This would have been one of the desired outcomes of quantitative easing. Last week, Fed vice chairman Donald Kohn said quantitative easing measures were under review at the central bank as normal contingency planning. The goal would be to encourage banks to lend more aggressively by coming in as a buyer at specified rates. Even though quantitative easing drove Japan into deflation, it was the key to turning around the economy and this is a risk that the US central bank may have to take.
Here’s where the major central banks stand and what is expected for the next meeting:
Federal Reserve – 50bp Cut Expected on 12/16
On October 29, the Federal Reserve took interest rates to 1 percent, which is near the record low reached in 2003 and 2004. While other countries have just started reacting aggressively to financial conditions, the Fed has been mounting cuts as far back as the middle of 2007. There has been no looking back since, as rates have been cut 425bp since 2007 and 250bp year to date. With interest rates near ultra low levels, the Federal Reserve has already resorted to unorthodox policy tools. More easing is expected with the markets torn between a 50 or 75bp rate cut in December. The FOMC statement will be particularly important this time around because the Fed will have the difficult decision of signaling a move to zero interest rates. In order to deal with this decision, they have expanded their monetary policy meeting from one to two days. Fed Chairman Ben Bernanke has remained dovish throughout the past few months which means that another rate cut is practically guaranteed.
European Central Bank – 50bp Cut Expected on 12/04
On November 6, the European Central Bank cut interest rates by 50bp to 3.25 percent. The European Central Bank has abandoned their old monetary policy metric in the previous months, opting for a more growth-concentrated approach to interest rate decisions. Such a change has accompanied a round of rate cuts that has brought the target rate down to 3.25%. ECB President Trichet has made no indication that rate cuts would stop here. However, in relation to neighboring nations, the ECB has not acted as aggressively, dropping rates only by 75bp this year. Compared to a year to date cut of 250bp by the US and 225bp by the UK, the ECB seems to be lagging behind the curve. Now that the region has officially hit a recession, it is possible that they will be more aggressive in easing rates. The ECB has the power to organize a continuous program of such policy implementation since their target rate is one of the highest, outside of Australia and New Zealand. The only factor holding them back is inflation pressures. Although producer and consumer prices have been easing, the central bank is not entirely convinced that the upside risks to prices have alleviated.
Bank of England – 100bp Cut Expected on 12/04
The Bank of England has been the most aggressive and proactive of the G-10 central banks in their attempts to ease monetary policy. The most recent cut of 150bp was a huge surprise to all traders and represents the largest single meeting cut to occur for any of the major central banks during the financial crisis. However what was even more shocking was the fact that the minutes from the most recent monetary policy meeting in early November suggested that they considered an even larger interest rate cut. Going into the December monetary policy decision, the market expects the BoE to ease by another 100bp. With the economy in a recession according to UK officials, interest rates could fall as low as 1% if the crisis continues well into the New Year. The BoE’s ability to cut by such a sizable amount was also reflected in the fact that inflation, once the primary concern, has eased considerably in the last few months. In addition to monetary stimulus, the UK government has been at the forefront of bank bailouts and fiscal stimulus.
Bank of Japan – No Rate Cut Expected on 12/19
After cutting interest rates by 20bp at last month’s meeting, the Bank of Japan left interest rates unchanged in November. It is unlikely that we will see much more easing as officials have expressed a certain sense of reluctance in bringing rates back to zero. The Japanese are all too familiar with the implications of such rates and will be forced to look for new methods to ease the financial strain on the country. Masaaki Shirakawa, the BoJ Chairman, instructed the Bank’s staff to “swiftly examine and report possible changes in the treatment of corporate debt as collateral, as well as possible ways to enhance flexibility in funds-supplying operations collateralized by corporate debt.” Such statements seem to indicate that, while we will unlikely see much in the way of new rate cuts, we will see new initiatives that focus on shoring up lending and improving liquidity.
Bank of Canada – 50bp Cut Expected on 12/09
On October 21, the Bank of Canada cut interest rates by 25bp to 2.25 percent, the lowest level since October 2004. Although the size of the rate cut was smaller than the market had anticipated, the BoC had already cut interest rates by 50bp on October 8th. Mark Carney, the Governor of the Bank of Canada, has been very vocal in explaining his thoughts on the health of the Canadian economy. Carney's comments can be summed up in this statement, “the risks to growth and inflation in Canada appear to have shifted to the downside…some further monetary stimulus will likely be required to achieve the inflation target over the medium term.” We can rarely expect such a “cut and dry” statement from a central bank official. He leaves little to question. However, he does note that the economy does have some strong areas, specifically domestic demand (retail sales rose 1.1 percent in the month of September). The BoC governor also noted that the weakness in the Canadian dollar has picked up some slack from the declines in international demand. The market expects the central bank to ease interest rates by another 50bp at the next meeting, which would take rates down to 1.75 percent. Canadian interest rates have not been below 2 percent since the 1960s.
Reserve Bank of Australia – 100bp Cut Expected on 12/02
The Reserve Bank of Australia has definitely not sat idly by watching its economy deteriorate. Along with 175bp of easing this year, the central bank has also resorted to intervening in the currency markets to support its currency. Intervention has been a very controversial monetary tactic because it simply does not have a good record. However, such desperation does indicate that the bank is having a tough time dealing with the consequences of rate cuts. A target rate of 5.25 percent leaves the RBA with plenty of opportunity for additional easing in the future. However, the RBA minutes explain that the 75bp cut made at the last meeting would be necessary in that “there was an advantage in moving the setting of monetary policy quickly to a neutral position.” Regardless of such a statement, the market still believes that the RBA will cut interest rates by 100 to 125bp at the December meeting.
Reserve Bank of New Zealand – 150bp Cut Expected on 12/03
The Reserve Bank of New Zealand cut interest rates rates by a full percentage point in October, citing “ongoing financial market turmoil and a deteriorating outlook for global growth." In a statement published in an article released by the RBNZ, the bank notes that “global developments have proven extremely disruptive and it will likely be some time before financial market conditions normalize. The Bank will continue to adopt measures as needed to maintain the stability of our financial system as far as possible in these difficult times.” Once again we see some very dovish statements made explicitly from central banks. The recession-embattled country has plenty of ammunition, as rates are at the very high level of 6.50%. While zero percent interest rates may not be a possibility, it is possible that we will be surprised by some extremely aggressive cuts. The market currently expects the RBNZ to cut as much as 1.5 percentage points in December and eventually take interest rates down to 5 percent. It is also important to note that rates have not fallen below 4.50% in the last ten years.
Swiss National Bank – 50bp Cut Expected on 12/11
The Swiss National Bank surprised the market by delivering a full percentage point intermeeting rate cut. Citing the obvious fact that international economic conditions have worsened, the central bank made its largest one-day rate change in eight years. The economy has weakened substantially due to the fact they have a large exposure to the banking sector. The Swiss National Bank hopes that the move will provide the market with a generous and flexible supply of liquidity. The bank’s continuous issuance of surprise rate decisions leads us to believe that more can be expected. Many economists expect the SNB to continue cutting interest rates to 0.5 percent.
Related Articles
|
Top Rated Comment Streams:
-
1.Hedged In662
- 2.
-
3.Smarty_Pants413
-
4.axelrod608307
-
5.cos1000278
- Free E-Newsletters
This article has 14 comments:
-
constructe
-
374 Comments
Nov 27 05:37 AM-
Asbytec
-
230 Comments
Nov 27 09:06 AM-
puddytat
-
13 Comments
Nov 27 09:17 AMLook at your GDP to debt ratio chart... If that doesn't scare the crap out of the US I just don't know what does. Yes... help the home owners because they pay taxes and drive the economy.... DO NOT push down rates in the hope this will stimulate people to get into MORE DEBT.
You have no more cash. You are insolvent. Stop spending money you don't have. What is the point of having cheap money if the price of the products... ie houses... are still astronomically high..
STOP SPENDING MONEY YOU DON"T GOT.
-
Asbytec
-
230 Comments
Nov 27 11:37 AM"DO NOT push down rates in the hope this will stimulate people to get into MORE DEBT."
Unfortunately, that's the problem. Debt is money and money is debt. I suspect you mean excessive money/debt. I'd agree. Our debt to GDP is scary, and probably means collapse. It's impossible to actually repay the immense consumer debt. The system must default.
In this case, reducing interest rates just prolongs the inevitable. A soft landing is the best possible outcome, in my view. But, the markets will have to correct, either now in Bush's waning months or on Obama's watch. At the least, I hope Obama works to maintain what little wealth we still have.
By the way, for those who argue with Kathy on her dollar outlook, one should realize she actually crunches the numbers. Many of the rest of us form opinions based on our economic knowledge and from market performers like Mr. Buffet and Mr. Rogers. Nothing wrong with that, surely. Just, one should listen to the data, too, as Kathy does.
My two cents or one euro's worth, whichever...
-
Dirk McCoy
-
3 Comments
My Website
Nov 27 11:53 AMHow did quantitative easing create deflation in Japan? Conventional wisdom is that increasing the money supply will creat inflation as more money chases a limited amount of goods and services and prices rise.
Coining money is actually one of the enumerated powers of our Federal government. When technology and trade create additional capacity for goods and services, relative prices must change. If money is constrained so that inflation becomes impossible, then deflation occurs. Debtors have a harder time making payments, and the wealthy start to hoard cash instead of spend or (risk) invest it. Velocity of money drops, and using the old formula MV=QP, economic activity (Q) has no choice but to drop.
As we live in a country where democratic value (in theory) is placed on ideas and labor moreso than wealth, it shouldn't be a surprise that government and its central bank at some point will be forced to increase the money supply. And given the enormous increases in technology (an entire new cyberspace universe to monetize) and trade (a billion new workers available to global trade), it should be obvious that the supply of money should have been increasing at an unprecidented rate. That it didn't- and that elaborate credit schemes emerged in its place- shouldn't be a shock. And that the stock of money will now increase on a massive global scale shouldn't be all that surprising- or worrisome- either.
-
lumpuckarutoo
-
2 Comments
Nov 27 12:31 PMI never hear about this in the news lately.
-
lumpuckarutoo
-
2 Comments
Nov 27 12:54 PMOn Nov 27 12:31 PM lumpuckarutoo wrote:
> ..I'm new to the blog thing and I'm not even sure I am at the right
> place but here goes, my comment is about the housing market and the
> mess that we are in , ... it seems to me that the adjustable rate
> mortgages (ARM) was the down fall and the cancer of the housing
> market and should have been outlawed right at the start, ...when
> those rates started to adjust upward to the point where people could
> no longer afford them, that's when they started to loose there homes.
> I also realize that with out them they couldn't have gotten a home
> and the greedy money lenders couldn't have gotten rich !
> I never hear about this in the news lately.
-
Asbytec
-
230 Comments
Nov 27 01:20 PMFirst, yes. In Oct 07, Bernanke told congress to act on the housing market. He pleaded with congress to shore up Freddy and Fanny. He pleaded with lending institutions to renegotiate home mortgages, keep folks in their homes and paying mortgages.
No one listened. Well, that is until home prices began falling drastically. We missed the window on saving the housing market.
And no, because the housing market is simply a small part of the problem. Our problem is our cumulative consumer debt resulting, in part, from the wealth affect due to rising home values. We borrowed money against our (non liquid) equity and turned it into liquid money. And not just by the face value of the equity loan, but through fractional banking, a hell of a lot more liquidity.
Americans are way in over their (our) heads. Our debt to GDP ratio is scary, very scary. But, that's how we make money, through debt. That's how we feel rich, by borrowing money from someone else. The problem is, debt can never be paid off. Never. It's impossible. So, there comes a point in time when the system laden with excessive debt (money) just has to collapse.
The housing market down turn started the ball rolling. It was the x-ray that showed we had cancer. But, falling home values, per se, are not the cancer. Excessive debt is.
And now that credit markets have essentially ground to a halt, we really have no more money to spend. As long as banks don't lend, we have no (new) money.
-
Emerald
-
177 Comments
Nov 27 02:01 PM-
zanardm
-
42 Comments
Nov 27 10:01 PM-
RatWatcher
-
23 Comments
Nov 28 01:47 AMOn Nov 27 09:06 AM Asbytec wrote:
> Agree. Don't prop up the housing market, but prop up families who
> will lose their homes, at least. And maybe renegotiate their home
> mortgages. Housing prices must correct.
-
nazb
-
1 Comment
Nov 28 08:44 AMat the moment two cents is 0.01 euro which is 100 times less that a euro
On Nov 27 11:37 AM Asbytec wrote:
> Thank you for your comment, puddytat (LOL...nice nic, BTW. Gave me
> a chuckle...)
>
> "DO NOT push down rates in the hope this will stimulate people to
> get into MORE DEBT."
>
> Unfortunately, that's the problem. Debt is money and money is debt.
> I suspect you mean excessive money/debt. I'd agree. Our debt to GDP
> is scary, and probably means collapse. It's impossible to actually
> repay the immense consumer debt. The system must default.
>
> In this case, reducing interest rates just prolongs the inevitable.
> A soft landing is the best possible outcome, in my view. But, the
> markets will have to correct, either now in Bush's waning months
> or on Obama's watch. At the least, I hope Obama works to maintain
> what little wealth we still have.
>
> By the way, for those who argue with Kathy on her dollar outlook,
> one should realize she actually crunches the numbers. Many of the
> rest of us form opinions based on our economic knowledge and from
> market performers like Mr. Buffet and Mr. Rogers. Nothing wrong with
> that, surely. Just, one should listen to the data, too, as Kathy
> does.
>
> My two cents or one euro's worth, whichever...
-
investor88
-
748 Comments
Nov 28 09:17 AM-
nfliman
-
1 Comment
Nov 29 08:17 PM