By Joseph Neu
With ZIRP over in the US, replaced by a Trump-fueled PIRP, how long can NIRP last?
A financial world turned upside down by negative interest rates likely will not last. The US Fed has dispensed with ZIRP (zero interest rate policy), and has shifted to PIRP (positive interest rate policy) with rate hikes as well as fiscal expansion and expectations for growth. This means that in response, Europe and then Japan will eventually be forced to follow suit. Part of the 2017 outlook, then, should be looking for signs of an end to NIRP (negative interest rate policy).
Rate fundamentals vs. differentials
In late November, HSBC economist Mark Berrisford-Smith told NeuGroup’s regional European treasurers to look out for an end-to-NIRP scenario. This was part of a larger discourse on the impact of Trumponomics on issues important to treasurers. As my colleague Anne Friberg highlights in the January issue of iTreasurer (see “2017–The Donald Debuts: Delights, Doubts, and the Dollar,” iTreasurer, January, 2017), one reason for this is currency driven.
First, differential US growth expectations and interest rates will fuel continuing dollar strength. But, there is also a consensus among banks that the dollar will peak before too long. For example, a recent Reuters FX poll suggests the euro will hold its own vs. the USD. Deutsche Bank, notably, is predicting the euro to trade below parity in Q2 at a rate of 0.95, but then also come back into its own by 2018.
With US 10-year yields at 2.44% vs. 0.2% in Germany and 0.04% in Japan at year end, and forecasted to head up toward 3.6% by Q2 (increasingly severe rate differentials), what might explain the currency view?
The first answer is that Trumponomics will hit headwinds that will be bearish for rates and the dollar. For example: fiscal expansion could hit a wall with budget hawks in Congress, killing a repatriation tax holiday and tax reform; Trump’s poor instincts on trade policies could undermine the growth agenda; investors globally will shift out of bonds, etc.
However, another way to justify these forecasts would be for negative-rate jurisdictions like the eurozone to abandon NIRP, which they may be forced to do if US growth proves more quick to substantiate itself and start to look more sustainable than expected. US success will encourage similar growth policies to proliferate. This position is far from the view that most forecasters are suggesting, but most note that 2016 proved again that the unexpected can happen and we are in uncharted territory in terms of both the pace and impact of change, plus our ability to process it.
Eyes on Denmark
Denmark may be the logical canary in the coal mine for negative rates, as it has had them for the longest (since mid-2012). The expectation is that it will continue with NIRP until 2018. The Danish central bank has resorted to negative interest rates largely to protect the krone’s currency peg with the euro, which is the currency of its major trading partner, Germany. Denmark has one of the largest current account surpluses in the developed world and uses negative rates to help keep the krone from appreciating at the hands of currency speculators and flight-to-quality risk investors appreciative of AAA-Danish government assets.
Even with negative rates, the Danish central bank has been forced to resort to currency intervention to maintain the peg, with a sizeable intervention post-Brexit and another one recently over year-end, in response to the Trump win.
However, according to Danske Bank, as noted by Bloomberg, the latest intervention of 700 million kroner (USD 100 million) was needed, not to push back on speculators, but to counter Danish pension funds converting (and hedging) USD gains from US equities that have been rising on positive, Trumponomics expectations.
As per Bloomberg, “Danske estimates that about one-third of Danish pension foreign holdings are in American stocks and a rally in US equities since November has driven up the value of those assets. Converting those dollar-denominated investments into kroner is putting pressure on the peg.”
Maintaining circumstances where investment gains (or savings) create problems is not something market participants should want to encourage—even in Denmark. Least of all pension funds, since they have had no easy time coping with NIRP; and the longer it prevails, the more difficult it becomes to match off liabilities with asset holdings, especially of the fixed-income variety. Danes earning money off their home mortgages may not be happy about an end to NIRP, but it is coming. Everyone should prepare before the krone comes off the peg, as this will signal the beginning of the end of NIRP not just in Denmark, but likely elsewhere.