2016: The Year of Negative Interest Rates

There aren’t many people in Australia who believe the RBA would send interest rates into negative territory. And with rates at 2%, some even think we’ve reached a floor.

Then again, there aren’t many who truly understand how central banks operate. So it’s not altogether surprising the public misreads central banks as often as they do. The majority still hold this flawed idea that central banks are independent organisations. But they’re not as autonomous as they’d have you believe.

Contrary to what many believe, central bankers are like a secretive clique. They cooperate with each other, setting a framework for global policy. They even have an international headquarters in Basel. And they use it for more than the odd Christmas party.

Central banks claim to work for the benefit of the economies and people they serve. But in reality they all follow the same principles. How can we be so sure? Because the global central banking philosophy is saturating every nation on the planet. This same philosophy that pushes lower rates and easier credit on economies.

And don’t for a second believe the era of bargain bin credit is over.

The Federal Reserve has done a good job of convincing markets it intends to star hiking rates. But every time they’ve hinted at it, they’ve gotten cold feet. When you start believing pathological liars, you only have yourself to blame when it breaks its promise.

Contrary to what the Fed is telling you, that’s not likely to change anytime soon. If anything the global era of easy credit is just ramping up.

How do we know? Have a look at what came out of Canada last night.

The Bank of Canada’s chief, Stephen Poloz, made some eye raising comments. Have a look at what he had to say:

The bank is now confident that Canadian financial markets could also function in a negative interest rate environment.

‘[These remarks] should in no way be taken as a sign that we are planning to embark on these policies. We don’t need unconventional policies now, and we don’t expect to use them. However, it’s prudent to be prepared for every eventuality.’

And here’s what sense the Canadian Broadcasting Corporation made of this:

To put it simply, the Bank of Canada now thinks negative interest rates are a policy option in its tool belt because the experience of other countries that tried them wasn’t calamitious. Negative rates, to varying degrees, achieved their goals without any undue negative consequences.

But that doesn’t necessarily mean that Canadian consumers would actually see negative interest rates — a mortgage that pays you to hold it, for example — even if the central bank goes negative, Poloz said, citing examples of what happened in other countries’ consumer lending markets once the central bank went below zero.’

It’s a stunning statement from Poloz. And the rationale used to support it is even more striking. ‘It worked (ahem) in Europe, so it’s good enough for Canada!’ As everyone knows, the European economic model is the beacon of prosperity. Oh wait…

What’s more, Mr Poloz can argue the BoC won’t lower interest rates below zero all he likes. But who prefaces an anti-NIRP stance by giving a direct plug to NIRP in the sentence before? Someone that’s giving serious thought of unleashing NIRP, that’s who.

Who needs negative interest rates when everything’s peachy?

Why does Canada need NIRP anyway? Didn’t they just exit recession? If the economy is recovering, it seems like NIRP should be the last thing on anyone’s mind, right? You’d think so.

In any case, it doesn’t take too long to see through the BoC’s doublespeak.

Just like the US and Australia, there is no economic recovery. It’s a phantom. A sham. If there was, there’d be no need for NIRP in Canada. But there is because Canada isn’t doing well, and it won’t be next year either.

The BoC are of the mindset the Canadian economy is set to rebound in 2016. It even expects the economy to gather momentum in 2017. Which sounds like the kind of forecast that should rule out any talk of NIRP full stop. And yet the BoC mentioned it anyway.

NIRP isn’t necessary in countries undergoing ‘economic recoveries.’  Maybe what the BoC is actually suggesting, but not saying, is that NIRP will help the Canadian economy rebound. Because it certainly won’t be doing that on its own. Especially not in a world where oil prices (Canada’s main commodity export) are heading towards US$20 a barrel.

Like Australia, Canada’s economy will depend on global growth next year. Yet nothing about the global economy screams ‘recovery’ at this point. And you’d be hard pressed to see what’s meant to change over the next 12 months.

And there’s another point in all this too. If markets really believe US interest rates are heading up, how can predict a global economic recovery? Any US rate reversal will put a major dent to any recovery. So it’s either a rate policy reversal, or a global recovery. Which is it? You can have one or the other, but not both.

And if the BoC is mulling NIRP, what makes everyone think the Fed wouldn’t too? Or the RBA for that matter?

Remember, central banks act in concert. They rarely make decisions in isolation from each other. The NIRP experiment started with European central banks. With that deemed a ‘success’, the program is ready to spread its wings. Next stop on the tour could be Canada, then the US, and then a stopover in Australia perhaps?

Why Australia is no different to Canada

Unlike the BoC, IceCap Asset Management, a Canadian investment counsellor, forecasts a very different 2016 for Canada. It expects its economy to fall back into recession next year. And it forecasts negative interest in Canada rates by late 2016.

Compared to Canada, Aussie interest rates still remain at a relatively high 2%. The BoC’s official interest rate is set at 0.5%. That puts Canada closer to NIRP than us. But it doesn’t mean we can’t sink a few percentage points in a short amount of time.

Beyond this difference, we’re like two peas in a pod. Like Australia, Canada’s prosperity is built on commodity exports. Both nations are rich, and of relatively similar size in population. Both are progressive, each with developed free markets. Together they rank among the most business friendly nations. And, most importantly, both live and die by what they sell to the rest of the world. For Aussie iron ore and coal, think Canadian oil.

I look at Canada as something of a benchmark for Australia. What it does, and where it goes, is a guide for where Australia could end up.

I’m worried that policymakers at the BoC are contemplating NIRP. We all should.

Mat Spasic,

Junior Analyst, Markets and Money

PS: Markets and Money’s Phillip J. Anderson says interest rates are set to remain low for a long time to come.

Phil’s written a brand new report, ‘Why Interest Rates Could Stay Low for the 21st Century’. In it, he warns that you won’t be able to rely on your savings to fund your retirement. As Phil says, inflation, from low rates, is eating into your savings. You can’t rely on savings accounts or term deposits for your retirement. The regular return on a term deposit has halved in the last four years alone!

That’s why Phil wants to show you the best way to invest in this low interest rate environment. He’s prepared a four pronged strategy that’ll boost your wealth. You’ll learn where to park your cash over the coming decades to profit immeasurably. To download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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