Friday, June 17, 2016

Denmark and negative rates

Bloomberg has an article on negative interest rates in Denmark. Unlike others who use negative rates as a tool of monetary accommodation to restore economic growth, the country had embraced negative rates as early as 2012 to maintain the kroner's peg against a depreciating euro.
Apart from highlighting the apparent normalcy associated with negative rates, the article points to atleast two interesting features of the Danish economy that goes against the grain of orthodox Econ 101. One, high taxation and high minimum wages may not always be bad,
Despite a minimum wage not far below $20 an hour and some of the world’s steepest taxes, unemployment is almost the lowest in Europe.
Second, despite the persistent low rates, the country's real estate market has suffered only a "froth" and not "bubbles" as would have been expected. Strict mortgage lending regulations may, after all, be effective
the country regulates the housing market to a degree unimaginable in the U.S. It’s nearly impossible for a foreigner with no connection to Denmark to buy property, preventing inflows of overseas money. Banks apply stringent financial criteria to mortgages for buy-to-let properties; it’s hard for Danes to purchase homes they don’t intend to live in. Regulatory guidelines require minimum down payments of 5 percent and stress tests of borrowers’ finances against runups in rates. With the encouragement of regulators, banks have hiked fees on flexible-rate loans, nudging buyers into fixed-rate mortgages. The rules are even tighter for properties in Copenhagen... Compared with New York, London, and even Stockholm, Copenhagen real estate is still a bargain: $500,000 buys a decent two-bedroom.
However, it should not be construed that such policies can be replicated to similar effect elsewhere. Denmark's unique social and political history and their attendant forces have undoubtedly played a critical role in the apparent relative lack of problems, maybe even success, with negative rates. But a more definitive conclusion is that this is yet more evidence that countries need to embrace a more heterodox approach and carefully select policies keeping in mind their local context and requirements. This, more than blind administration of economic orthodoxy, even with negative rates, is more likely to help economies forge successful growth paths.

As to negative rates itself, in a week when Germany joined Japan and Switzerland with negative rates on 10 year sovereign bonds, its future may well depend on the answers to at least five questions.

1. How much low can the rates fall? Beyond a point, the transmission of rates into retail and all other parts of the economy will be felt, with potentially very disruptive consequences. Fundamentally, at a certain point, the negative rate would exceed the cash storage cost.

2. How much longer can the banks hold out? Apart from having to pay the central bank for holding their reserves, banks have been constrained from passing on negative rates to depositors. This has been eroding their profitability as reflected in declining Net Interest Margins (NIMs).

3. How much long will it be before the savers revolt? These low rates are exacerbating the woes of the already insolvent pension funds in many parts of the world. Insurers are struggling for returns on their investments and asset managers are fighting to retain their investors. And, coupled with negative retail deposit rates, the cumulative effects low rates may become onerous enough to force savers out into the streets.

4. How much more skewed can the risk allocation become? As returns on conventional assets decline, it is only natural that investors move into newer and riskier areas in search for yields. But this in turn invariably amplifies risk by inflating bubbles. The more time markets stay in these regions, the steeper the fall.

5. How much longer can the markets sustain central bank purchases? The negative rates owe a lot to the massive sovereign bond (and now corporate too) purchases by central banks, especially the ECB and BoJ. But there are portfolio limits to how much of each category that the central banks can purchase. In Europe, since the ECB can buy no more than a third of any individual bond issue, there may be only 3 months worth of German bonds left to purchase at the current rate of nearly 20 bn euros a month. The Bank could be left owning a fifth of the sovereign bond market in Eurozone area by end-March 2017. In Japan, thanks to the BoJ's ETF purchases, the Japanese government is a top 10 holder in 90% of Japanese stocks.

No comments: