Way back in August 2012, I first posted an article on negative interest rates. At that time, the European Central Bank was discussing the possibility of setting rates below zero, however, it was a very little-discussed monetary policy in the mainstream media. Since then, things have changed markedly; the mainstream media is all over the concept of zero interest rates but spend little time looking at the impact on consumers. As a central bank watcher, I want to quote from two central bankers who have recently stated that they would be willing to implement a policy that would punish already beleaguered savers and further reward those who are overly indebted, among them, governments who are already benefitting from near zero interest rates.
Let's start with a quote from Janet Yellen, Chair of the Federal Reserve who recently commented that she would be willing to entertain the use of negative interest rates during a Financial Services Full Committee Hearing:
Here is the question and answer:
"Rep. Tom Emmer (R-MN): "Will the Federal Open Market Committee ever rule out going to negative interest rates?
Ms. Janet Yellen: "'Rule out' is something we tend not to do. [...] If circumstances were to change, suppose economic outlook--which I don't expect--but if it were to deteriorate in a significant way, so that we thought we needed to provide more support to the economy, then, potentially anything including negative interest rates would be on the table."
Note that she says that the purpose of negative interest rates is "to stimulate risk-taking".
In case that wasn't clear enough, here is the dot plot from the Federal Reserve's meeting in September 2015 showing that at least one member of the FOMC is considering a negative rate policy for 2016:
Now, let's switch to Canada. Stephen Poloz, Governor of the Bank of Canada recently gave a speech at the Empire Club of Canada in Toronto, Ontario and during a press conference, stated the following:
While not saying that the imposition of negative interest rates is imminent, Governor Poloz is making it clear that the Bank of Canada is adding a negative interest rate policy to its inventory of monetary policy "goodies".
Here is the press release on how the Bank of Canada is updating its framework for unconventional monetary policy measures:
Note that the Bank of Canada has now dropped its effective lower bound for its policy interest rate from 0.25 percent to minus 0.5 percent.
What does this mean? As I noted in the opening paragraph, it means that savers will suffer and borrowers will continue to borrow at extremely low interest rates. Savers have already suffered as shown on this graph from FRED which shows that the interest rate on non-jumbo five year certificates of deposit have remained well below 1 percent since early 2013:
Now, let's go back to that imaginary $100,000 that you have lying around, waiting to be invested to provide funding for your retirement years. Here are some income scenarios:
$100,000 at 6 percent - interest income $6000 per year
$100,000 at 5 percent - interest income $5000 per year
$100,000 at 0.8 percent - interest income $800 per year
As you can see, savers have taken a significant interest income haircut in this low interest environment. The current low interest rate environment has made it almost impossible for retired investors to avoid spending their capital if they choose to invest in low risk investments, thus, the flight to junk bonds, equities and other higher risk investments. Stay tuned, the situation gets even worse in part two of this posting.
Let's look at what will likely happen in a negative interest rate environment. We need look no further than the example of Switzerland. Here is a graphic showing what has happened to Switzerland's official interest rate over the past ten years as set by the Swiss National Bank:
Right now, the Swiss Average Rate Overnight (SARON) is set at minus 0.72 percent.
Switzerland is not the only country with a central bank that is experimenting with negative interest rates. Sweden's Riksbank currently has its repo rate set at minus 0.35 percent and its Stockholm Interbank Offered Rate (STIBOR), the interest rate at which a number of banks active on the Swedish money market are willing to lend to each other without collateral, is set at minus 0.411 percent as shown on this screen capture:
While the concept of negative interest rates may seem rather abstract to all of us, not surprisingly, there will likely be a cost to consumers who happen to bank in these nations and in any other nation that adopts a negative interest rate policy. Alternative Bank Schweiz has already broken the ice, announcing in mid-October that its will begin to impose interest charges on deposits in 2016. For current accounts, the bank will impose a minus 0.125 percent rate which increases to minus 0.75 percent rate on deposits greater than 100,000 Swiss Francs ($101,100 US). This is the first bank to impose interest charges on individual depositors; several Swiss banks including UBS and Credit Suisse have already passed along the pain of negative interest rates to their larger institutional clients.
Let's close this posting with a graphic showing the odds of a recession occurring in 2016 according to JP Morgan:
It looks like there is a good chance of a recession hitting the global economy in 2016. With central bankers out of traditional and already proven marginally effective monetary ammunition, it is just a matter of time before negative interest rates are a reality in North America, the rest of Europe and the South Pacific. Central bankers are floating trial balloons, gauging public reaction to negative interest rates and preparing us for the inevitable. Once negative rates are in place, it's just a matter of time before anyone that has money on deposit with their local bank is paying for the privilege, particularly since Big Banks are always on the lookout for a new and highly lucrative source of profits. If you thought that the income haircut that savers have taken on their low interest, low risk investments was bad, just wait, the worst is yet to come!