The announcement by the bank that it is preparing to impose negative interest rates on wholesale deposits is a classic sign of deflation.
Attempts by governments and central banks to force economies out of recession appear to have failed. Both conventional methods (cutting rates) and unconventional ones (quantitative easing) have been tried, and neither has borne fruit.
“In its grand...experiment the Fed pushed rates to zero, flooded the world with cash, then expected banks to lend and businesses to expand. Did it work?” asks Mish Shedlock.
“Clearly not,” he answers. “No-one wants to put that cash to use. If you were a business would you be hiring here? I wouldn't, and neither are businesses. Instead cash sits in banks or short-term treasuries earning zero or even negative percent.”
Banks only want to lend to creditworthy customers, says Shedlock, while the only clients who want to borrow are the riskier ones. The result is stalemate.
The imposition by BNY Mellon of negative deposit rates came as US government bill yields hit zero and the rate on overnight repurchase agreements (repos) went below that threshold, according to a report in the Wall Street Journal.
BNY Mellon has seen large inflows of cash from its institutional customers, which it then has to park in assets like T-bills and in secured deposits. If it’s having to pay to do so (via negative rates), it wants to be able to pass this cost on to clients. If it holds the cash on its own balance sheet, the bank has to pay higher capital charges and extra costs for deposit insurance.
What happens next? Negative rates make the hoarding of cash even more likely. That equates to a further slowdown in monetary velocity and, necessarily, in economic activity.
Below-zero interest rates threaten instability elsewhere. The US money market fund model of not allowing values to drop below a dollar a share, or to “break the buck”, would become completely unsustainable under such circumstances. Perhaps it’s not coincidental that last week saw the second-largest outflows ever from this type of savings vehicle, according to a Lipper report from yesterday.
Will the US government step in again to underwrite money market funds’ NAV at US$1, as it did in 2008? After the recent battles over fiscal policy, this seems less certain. And, according to a Moody’s report, cited last year in the Wall Street Journal, financial support from money market funds’ managers themselves might be less forthcoming than it was in 2007-09, when firms pumped in a total of US$12 billion to prop up valuations. If these funds, which are used as alternatives to bank accounts by many Americans, do break the buck, deflationary expectations will become entrenched.
Gold and silver have been unsurprising beneficiaries of the current market instability, even though Thursday saw a sharp late-day sell-off in both. Negative money market interest rates don't sound like bad news for precious metals, though, and the end of their bull market still seems some way ahead.
As for the equity markets, where analysts have, until very recently, been expecting a rise in the S&P 500 index’s earnings by 17% this year and another 13% in 2012, to new records, a deflationary economy will require...let’s just say, some adjustments to forecasts.