How nominal interest rates can become deeply negative

November 10, 2015

A recent IMF paper suggests that sizeable negative policy rates could be implemented in developed economies. The key would be a variable deposit fee at the central bank cash window that can enforce value decay of paper currency relative to electronic money. Despite legal and economic issues, the proposal is disconcertingly practical in light of the expansion of electronic payments. Its mere consideration would be a tail risk for fixed income markets.

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Understanding “liftoff”: how Fed policy tightening would actually work

July 25, 2015

A new “primer” explains how the Fed would tighten policy under current “superabundant liquidity”. Similar to the past, the focus would be on the fed funds rate, not the balance sheet. Unlike in the past, the fed funds target would be a range and pursued by setting in the interest rate on excess reserves (cap) and conducting reverse repo operations (floor).

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The deflationary bias of low interest rates

July 12, 2015

Compressed interest rates raise the risk of hitting the zero lower bound. A new theoretical ECB paper shows that even before the ZLB is reached this creates a deflationary bias, as inflation expectations shift lower, real rates rise, and consumption and pricing power decline. To counter this bias central banks would need to accept positive output gaps (tighter labour markets) or even increase their inflation targets.

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Setback risks for international USD lending

July 4, 2015

The BIS annual report emphasizes the dollar’s pervasive influence on international financial conditions. Post-crisis non-conventional Fed easing has spurred a global credit expansion, including economies that did not need it. Conversely, Fed tightening would reverse easy financing on a global scale, including countries that are ill prepared for it. FX depreciation is unlikely to insulate small and emerging economies from credit tightening.

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The four components of long-term bond yields

May 23, 2015

A BOJ paper proposes an affine terms structure model for bond yields under consideration of the zero lower bound. It estimates the contribution of [i] expected real rates, [ii] real term premia, [iii] expected inflation rates, and [iv] inflation risk premia. In the U.S. yields have been driven mainly by expected real rates and real term premia in recent years. In Japan inflation expectations and inflation/deflation risk premia have played a greater role.

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The dangers of ultra-low interest rates in Europe

May 3, 2015

Negative nominal interest rates and term premia are an issue for financial stability in Europe, according to a recent speech by the Deputy General Manager of the BIS. Duration risk has surged and banks’ exposure to sovereign credit and long-term rates has been compounded by flawed capital regulation. Governments find it easier to live with high debt levels for now, but at the expense of a weaker financial position of insurance companies and pension funds.

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The “collateral channel” of monetary policy

April 11, 2015

The importance of collateralized transactions for the global financial system has greatly increased since the financial crisis. Moreover, the influence of central banks on supply and pledgeability of collateral has become more pervasive and explicit. Investment managers must calculate with the impact of central bank policy and operating frameworks on financial conditions via this “collateral channel”.

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Monetary policy risk management in the U.S.

April 3, 2015

A Chicago Fed paper argues that economic uncertainty at the zero lower bound (ZLB) should be a cause of looser monetary policy. This is basic risk management, as confirmed by Fed Chair Janet Yellen. Near the ZLB unduly tight monetary policy is more difficult to correct than unduly easy policy. Moreover, the mere risk of being constrained by the ZLB tomorrow affects expectations already today and can reinforce the severity of the ZLB constraint.

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The evolution of China’s monetary policy

March 15, 2015

China’s economy has long relied on compressed interest rates in conjunction with strict capital controls and a tightly managed exchange rate. A new ADBI paper suggests, however, that modest liberalization and gradual internationalization of the renminbi since 2005 have lessened state control over financial parameters. Inconsistencies and risks of market dislocations have become more evident.

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An updated guide to ECB non-conventional monetary policy

February 13, 2015

The ECB now runs one of the most complex monetary policy regimes. Beyond regular liquidity supply, its operating framework features long-term full-allotment refinancing operations, generous collateral acceptance, and a commitment to conditional open-ended interventions in sovereign markets. Subsequently, it has adopted or expanded forward guidance, targeted lending and large-scale outright asset purchases.

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