Negative Rate World (NRW) – a wiki of unintended consequences

The world has seen negative interest rates before – Switzerland set interest rates below zero for foreigners in the 1970s in order to slow flows into the Franc.  But today’s negative rate environment is far more widespread, with Switzerland, Denmark, Sweden, Japan, and the Eurozone all setting negative policy rates.  Lots has been written about the intended transmission mechanisms of negative rates – cheaper direct borrowing costs for households and businesses leading to stronger economic activity, a portfolio rebalance effect in which investors sell low/negative yielding assets to buy riskier instruments, thus reducing funding costs for companies, and, controversially, reducing the attractiveness of an economy’s currency in a world in which competitive devaluation is seen as desirable.  This blog however hopes to capture some of the other consequences of negative rates, some unintended, and some creating different problems for policymakers.

I’ve started this list with 10 observations, but I plan to update it periodically as we see how the Negative Rate World (NRW) develops over the months or years ahead.  I’d like to ask for your help in spotting any interesting behavioural changes and historically important news stories.  You can put them in the comments below, or send us links through Twitter (@bondvigilantes) or email. Sourced facts are the best facts, but I will also consider anecdata.  Some links below may require subscriptions, most don’t.

  1. If you are an organisation that sits on large amounts of cash, negative rates are an unexpected cost.  For example, insurance companies have been used to taking premia from customers and making a return on that invested cash.  In a negative rate world, early payment of a premium is a drag on your returns.  That’s true for all companies – late payers become your most valuable customers.  It’s also true for the tax authorities.  In Zug, the Swiss canton, the taxman has asked taxpayers to delay paying their bills for as long as possible.  Zug calculates this will save the canton SFr2.5 million per year.
  1. Sales of safe deposit boxes are soaring.  By removing your cash from a bank account and locking it away at home, or in a secure facility, you can guarantee that zero is the worse interest rate you will receive.  You’ll also be immune from any bail-in of depositors if a banking sector gets into difficulty (Cyprus for example).  Japanese hardware store Shimachu says that sales of safes are running at 2 ½ times what they were a year ago.
  1. It’s not just households that are stashing the cash in order to avoid paying to save.  German insurance company Munich Re is experimenting with physical storage of banknotes.  To start with it will store €10 million in notes.
  1. If storing physical cash disrupts the transmission mechanism, what can central banks do to make it difficult to do?  Mario Draghi of the ECB has suggested that they might scrap the 500 euro note, which accounts for 30% of cash in circulation.  He talked about the note being used as a store of value for organised crime, rather than as an inconvenience in the operation of monetary policy, but it’s clearly a factor.
  1. Financial authorities might also be preventing – either explicitly through regulation, or through the age old “raised eyebrows” method – the withdrawal of large sums of cash by banks, pension funds and insurers.  In Switzerland a bank seems to have refused to allow a pension fund to remove a large sum of cash from its account in banknotes.  The SNB has apparently asked banks to be “restrictive” with such payments, to the annoyance of the Swiss pension fund association.
  1. There’s a technology and administrative burden that comes with negative rates.  Financial institutions have had to change computer systems, legal contracts have had to be altered (for example the ISDA swap agreements), bond documentation (floors on FRNs) redesigned.
  1. With 12 month Euribor turning negative in February 2016 for the first time ever, Spanish property owners – who generally have mortgage interest payments set on this measure, with no floors at zero – are seeing their outgoings collapse.  Spanish Bankinter also offered mortgages linked to Swiss rates, and some customers are due payments from the bank each month (in practise the bank is reducing the principal owed rather than paying over the cash).  The Spanish mortgage sector was often quoted as a reason the ECB would never go negative, as it would have a big P&L hit to the banks.  A similar reason, related to the UK building society sector, has been used by the Bank of England to justify keeping rates at a relatively high 0.5%.
  1. A different scenario has had an impact on the Swiss banking sector.  Perversely, mortgage rates in Switzerland offered by banks rose in the aftermath of rates turning negative.  Retail banks there realised they would find it difficult to pass on the negative rates to depositors that they themselves were being charged on reserves by the SNB.  In order to keep their profits at a similar level they therefore need to charge borrowers more, and lending rates rose.  Swiss insurance companies also offer mortgages, and fund through longer dated bond issuance rather than deposits – thus they were able to pass on lower rates to investors, and have become relatively more competitive compared to the banks.
  1. As we’ve seen, the ability to remove banknotes from the official system can interfere with the operation of the monetary policy transmission mechanism, effectively flooring rates at zero for those who do it.  This means that the topic of electronic money has become a live one.  Modern economies are generally moving in this direction anyway: credit cards, mobile transactions, Paypal, e-banking have developed exponentially in recent years.  In Sweden, cash now represents just 2% of the economy compared with 7.7% in the US and 10% in the Eurozone.  In part, Sweden’s reduction in cash usage was driven by new rules aimed at reducing tax avoidance, although it is also an early adopter of new technologies.  The reduction in cash in circulation means that there are fewer hiding places from negative rates.  Could the authorities eliminate paper money entirely?  It’s even something that the Bank of England’s Andy Haldane has discussed in the context of setting negative rates.  I’d advise you never to discuss such a thing in public however, as it drives some people absolutely crazy.
  1. As mitigants to the unintended consequences of negative rates, most central banks have tried to minimise the damage that negative rates can do to banks’ profits by introducing tiered interest rates.  Different levels of rates apply to different portions of banks’ reserves.  In Japan’s case, reserves held before rates went negative would still earn 0.1% for example.  Banks are generally incentivised not to convert reserves into banknotes as any such reduction is taken from the highest interest rate tier, rather than the most deeply negative.

What have we missed?

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Jim Leaviss

Job Title: CIO Public Fixed Income

Specialist Subjects: Macro economics and fixed interest asset allocation

Likes: Cycling, factory records, dim sum

Heroes: Brian Clough, Morrissey, Neil Armstrong

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