Cutting interest rates has been a key tenant of the monetary policies around the globe since the financial crisis. As a result the overnight cash rates of major economies around the globe have been near zero for more than half a decade. Interest rates are near zero across the major economies and there is simply no more room to cut.
The yields on traded bonds are pricing in negative yield as market is extrapolating the current low yield to last for a very long time. This is a negative sign on the prospect of future economic growth as long term bond rates can be an indicator of market expectation of the rate of economic growth over the same time frame.
Central Bank Status Update
It has been 7 years since Bank of England has changed interest rates. Mark Carney disappointed the markets in July in leaving rates unchanged with GBP rising immediately above 1.34 but it is widely expected to cut in August in reaction to the economic slowdown post Brexit.
The recent strong unemployment and retail sales data coming out the US looks to give more reason to raise rates than not but the market is not pricing in a rate rise until next year. We disagree as we are more bullish in our US dollar forecast.
Bank of Japan post Shinzo Abe election victory has renewed push by Japanese government in another round of economic stimulus through both monetary and fiscal policy.
Rise of Helicopter Money
The shift in the optimal means of stimulating the economy has moved from buying bonds to “drop” money across strata of population.
While people take offence at the notion of giving away free money. The above idea is an analogy to spread spending across the economy to drive economic growth.
The notion of helicopter money replicates this from the monetary perspective where money is giving out to encourage spending, which drives sales, which drives revenues which drives profitability and employment demand to meet the higher revenues.
The idea of giving money away is to increase the rate of money flow in the economy is not new. In Keynes general theory, Keynes response to the high unemployment rate during the Great Depression was that “The government should pay people to dig holes in the ground and then fill them up.”.
Limited recovery in income growth and jobs should not be blamed on central banks but lack of government fiscal policy. The misdirection on focusing on tax cuts which is a blunt tool that does not provide targeted stimulous and total debt levels fails to understand government does not operate like a business.
Government policies are not aimed to drive profit maximization but societal social goals. Key factors driving policies like education, health, law and order are political not economic decisions .
Failure of Quantitative Easing
Quantitative easing programs was designed to flood the economy with money by buying government bonds. Unfortunately the central bank did not envisage the failure in the transmission mechanism in the flow of cash proceeds from the purchases. As bond holders sold the bonds, they reinvested the proceeds back into bonds. The flow of funds remaining bonds means that it is driving the value of other bonds not yet bought back to record highs and hence the implied yield to record lows.
The fall in treasury bond yields also had the affect of pushing the value of other asset classes from equities to residential and commercial property to record highs as well. The intended effect of bond holders spending the money received from central bank purchases did not materialize but had the opposite effect. As interest rates are at record low, existing investors required to save more to obtain same dollar return to meeting living expenditure down the track.
QE had the marginal impact on employment growth as spending did not react in proportion of bonds bought overtime. We see the key failure of QE is the distribution impact where existing asset owners benefited the most from inflation in asset prices while lower income households that required the most support faced austerity and limited income growth.
Just as the generation ago saw interest rate peak at high teen percentages and looking back with awe. A generation from now will look back at record low interest rates with awe. Bonds are a sell of a life time.