By Chris Berry (@cberry1)
For a PDF copy of this note, please click here.
It is widely acknowledged that credit is the lifeblood of an economy. It provides the leverage for growth. The interest rate assigned to a fixed income security can then be thought of as the “cost” or “price” of the credit.
This makes sense as lenders want to ensure their assets (cash, typically) earn a return above the risk free rate. To be clear, there is much more to determining an interest rate, but this is the basic premise.
What happens, though, when that rate goes negative?
This note is a primer on negative interest rates, a phenomenon not unheard of, but increasingly en vogue in the wake of the Bank of Japan’s surprising (or maybe not so surprising) announcement to set the interest rate they charge commercial banks to deposit money at the BoJ at -0.1%.
By Chris Berry
For a PDF version of this note, click here.
- To call Q3 “challenging” is an understatement. Growth momentum is increasingly absent.
- Most metals were relentlessly forced downwards in Q3. Gold declined .13% (almost wiping out its gains YTD), silver fell .11% (down 13% YTD), and copper swooned 4.96% (down 9.42%YTD).
- Rather than pinpoint an “elephant in the room”, there are multiple negative catalysts including slower growth in China, a relentlessly stronger US Dollar, and excess commodity supply.
- Geopolitical events including the downing of Malaysian airline’s MH17, the potential spread of the Ebola epidemic, and the “rise” of ISIS have not had a significant effect on metals prices. The “metals” disconnect has many analysts, myself included, puzzled.
- It raises the question of whether or not the current downturn is structural rather than a “normal” cyclical downturn from which we always expect to recover.
- Q4 themes and catalysts may include a stimulus package in China aimed at boosting consumption, continued US Dollar strength (negative for gold and a deflationary precursor) , an announcement of QE in the Euro Zone, and the end of QE in the US.
In Deflation’s Grasp?
We have discussed the inflation/deflation debate many times in the past. It now seems clear that deflationary forces are predominant. Falling commodity prices, sparked by excess global supply and muted demand, aging societies, a stagnant velocity of money, and the ubiquity of technology continue to conspire to suppress and overwhelm the Federal Reserve’s attempts to stoke inflation.