Paramount / "Deep Impact"
At the beginning of 2016, negative interest rates were everywhere. People were fascinated by the potential implications of a form of monetary policy that had never been witnessed before, with advocates and naysayers equally vocal in their opinions.
Negative interest rates may have dropped off the radar a little in the chaotic aftermath of Britain's vote to leave the EU and with the developing banking crisis in Italy taking centre stage, but with more than $13 trillion of global debt now yielding below zero, negative interest rate policies (NIRPs) are still a crucial part of the global economy.
There seems to be an increasing consensus among many market participants — especially banks — that negative rates are doing more harm than they are good, and have essentially been a failed experiment. In June, for example, analysts at Citigroup railed against negative rates, variously calling them a "seeping poison" and suggesting they are a "completely irrational policy."
Analysts from Nomura, in an in-depth research note on the global impacts of persistent negative interest rates, seem to concur with Citi's view, and identified seven reasons why negative interest rates could be seen as a risk to the global economy:
"Persistent negative rates can feed into expectations about low growth and low inflation, dis-incentivising investment and counter-productively incentivising de-leveraging (as corporates and individuals avoid the likelihood of holding cash) and financial engineering," Nomura argues.
The lower interest rates are, the lower the potential for further monetary easing in the future.
The longer negative interest rates exist, Nomura argues, "the more innovative approaches to avoid cash usage will crop up."
There are potential legal complications if negative yielding reserves are used as collateral or for payments.
"Banks’ profitability is hurt and their ability to function is called into question. If banks absorb the negative rate on reserve deposits, their profitability is hurt despite potential capital gains on bond holdings and reduced bad loans. Banks may alternately choose to keep the zero bound on deposit rates but raise rates on certain types of loans, which is again counterproductive." Nomura cites the example of Switzerland, where mortgage rates have gone up since the country started experimenting with negative rates.
As Nomura argues "even the efficacy of lower rates is debatable in an environment where liquidity and savings are ample, companies are cash rich and investment opportunities are perceived to be lacking. Nomura Research Institute’s Richard Koo has long argued for fiscal policy solutions in such a “balance sheet recession."
"Another risk is the high concentration of positions in duration and quality and alternatives. Distortion of investors’ natural risk habitat to become driven by loss aversion may create the premise for heightened volatility in the future," Nomura notes, but points out that this is a problem "for another day."
Regardless of the risks associated with negative rates, they're likely to stick around for some time yet. With the economic picture not improving anywhere near as fast as expected, the likes of the European Central Bank, the Bank of Japan, and the Swedish Riksbank, are unlikely to take rates back above the zero lower bound anytime soon.