With the Federal Reserve recently raising interest rates for the first time in many years, the U.S. economy may be at the beginning of a transition away from the ultra-accommodative monetary policy environment that has existed since the global financial crisis. However, central banks in other major developed economies are not following suit—in fact, they are still trying to counteract the current low growth, low inflation economic environment.
The latest tool that they’ve turned to is the introduction of negative interest rates. At this point, most of Europe and now Japan has officially crossed the threshold from ZIRP (zero interest rate policy) to NIRP (negative interest rate policy)—see the chart to the right.
In the eyes of the central bankers, this is just an extension of what they’ve already been doing to stimulate their economies through periodic interest rate cuts and large scale asset purchases (quantitative easing). Only now, they’re actually imposing a small penalty on bank reserves through negative rates to further encourage banks to lend money into the real economy instead of having large balances sit idle with the central bank.
The intention is admirable, but markets don’t seem to be cooperating the way they normally do following central bank actions that loosen credit. Over the past several years, the market reaction has typically been positive whenever central banks announced a new policy initiative to ease monetary conditions: Stocks would go up, while currencies tended to fall. But more recently, we’ve seen a reversal of those trends in both Europe and Japan with stocks unexpectedly falling and currencies rallying. This seems to be related to concerns about potential unintended consequences of negative rates, particularly the negative impact on profitability in the banking sector.
The question this raises for investors is whether central banks may be approaching the limits of monetary policy. Markets certainly seem to be suggesting that may be a real possibility based on the recent volatility. If this is the case, then it would mean that one of the big supports that has been helping to boost asset prices is beginning to fade. In other words, pushing further into unconventional territory with the introduction of negative rates may be doing more harm than good.
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