QE is deflationary. Negative interest rates are also deflationary. Why? Because despite the belief of many, investors do not spend more when faced with lower interest rates. Instead people are forced to save more to boost their now depleted incomes. In short, we do not believe that either is an effective strategy to avoid the deflationary spiral, or spur growth. Unfortunately for the likes of the BoJ and eurozone, there was very little ammunition left on the table to deploy. In Denmark, where negative rates were adopted almost four years ago, studies show that NIRP is counter-productive as the private sector for example is actually saving more than when rates were positive!
With roughly $10tn worth of negatively yielding government debt (14 major nations have at least one negatively yielding benchmark debt instrument), what amazes us is the investor appetite for such products. A study carried out by rating agency Fitch shows that investors are losing ~$24bn annually by holding such securities. In fact insurance companies, pensions funds and banks appear to be moving onto higher yielding alternatives, such as US Treasuries, in order to maintain profits or even plug their deficits. What is the result? Well this only then makes it harder for the US to raise rates.
NIRP did get a mention earlier this year when Fed Chair, Yellen told congress that the central bank was “taking a look” at NIRP. Her views have since changed as the global backdrop recovered somewhat, so the Fed are now “not actively” considering it. Atlanta Fed President, Lockhart earlier this week stated that he does “not think negative interest rates are in the offing here in the United States anytime soon.” Global growth concerns seem to have reemerged this month as weaker data out of the US, considered as the driving force of global growth has dampened sentiment. As the market continues to push the probability of a Fed fund rate hike into the back-end of this year, with some market makers calling for May 2017, one has to wonder whether the Fed also have too few tools to unleash.
Friday’s non-farm payroll data release for April recorded only 160,000 jobs added which was below expectations of 200,000 and compares with a downwardly revised 208,000 jobs added in March. The unemployment rate was unchanged at 5% and the participation rate edged down to 62.8%. Average hourly earnings edged up to 2.5% yoy against expectations of a 2.4% yoy increase and average hours worked edged up to 34.5 from 34.4 in April.
Jobs growth has been one of the strongest data points on the US economy but today’s data also showed some signs of the weakness that has been evident in other data points. US Q1 GDP data showed the economy only expanded 0.5% on a quarterly annualised basis with ‘sluggish consumption’ growth of 1.9% and business investment falling 5.8% was particularly concerning. Weakness has also been evident in broad based indicators such as the Chicago Fed National Activity Index, a composite of 85 monthly indicators where a positive/negative reading corresponds to growth above/below trend, with the March reading at -0.44 and the prior reading revised down to -0.38. This is not yet at recessionary levels but growth looks anaemic at best. It is worth keeping an eye on the inflation data which while still benign, has edged higher over the past year: in March core PCE was 1.6% yoy and CPI ex food and energy was running at 2.2% yoy.
Any FOMC decision remains data dependent, and the Fed has been keen to keep its options open and not to rule out a June rate rise, but this looks extremely unlikely at this stage. At the time of writing the Fed Funds futures market is only pricing in a 4% chance of this, compared to 10% ahead of the employment figures and over 70% at the start of the year. Even if the data improves and another US rate rise is warranted later this year, we expect the Fed will remain ‘ahead of the curve’ and the yield curve will flatten favouring positioning at the long end on a duration weighted basis. In a world where around $10tn of government bonds trade at negative yields, high quality eurobonds offering positive yields, particularly from creditor nations, look compelling like investments.