Negative Rates: Why They Cannot Depress Currencies

by: Enzio von Pfeil

How come negative interest rates have stopped depressing their respective currencies? Investment implications.

1. Backgrounder

The Financial Times (FT) ran an intriguing analysis on this on p. 20 of its 16th February edition. We will cite liberally from it. Negative interest rate policy (NIRP) was introduced by Switzerland, Denmark and Sweden some years ago " tackle a combination of interrelated concerns: unwanted rising currencies, weak growth, low inflation and capital inflows." The European Central Bank joined the NIRP party in June 2014, and the Bank of Japan at the end of this January.

2. What Makes NIRP Work: Theory

"The idea is that NIRP and/or quantitative easing should depreciate currencies as it drives investors to seek out better-yielding assets elsewhere. That is most likely when a number of factors are in play: signs of perceptible growth abroad, an overvalued currency, (and) the NIRP country running a current account deficit."

3. Realities

In fact, all currencies festooned with negative interest rates have risen since around November 2015! Why so? "There are precious few signs that those conditions to make the NIRPs of the ECB and BoJ effective. Both run significant current account surpluses, prospects for emerging markets growth are small, and their currencies are up against an increasingly dovish line from the Federal Reserve, serving to weaken the dollar."

4. Two Other Countervailing Forces

Negative rates cannot depress currencies when these are deemed to be "safe havens". Step in the Swiss franc, euro and yen: curiously, people deem particularly the latter two to be safe havens. Beats me. Besides, negative rates work only if others are keeping their rates positive. Well, even Camel Yellen came out recently stating that the FOMC is toying with the idea of negative rates. And when the ECB meets on 10th March again, expect "Mario Kuroda" to announce yet more easing, aka an even more pronounced NIRP.

5. Investment Implications

Don't expect negative interest rates on their own to drive down the exchange rates of these magnificent five currencies of Switzerland, Sweden, Denmark, the euro and the yen. Instead, expect emerging market currencies to take the hit. Crazily, then, expect MORE capital inflows into the magnificent five and America; this will create our Economic Clock's® "excess supply of money", which in turn must propel their stock markets. Sapienti sat?

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