As is typically the case, Federal Reserve (Fed) watchers and market commentators, including me, will be debating right up to the September 20-21 Federal Open Market Committee (FOMC) meeting whether Fed Chair Janet Yellen said anything about raising rates in her address last week at Jackson Hole, Wyoming.
In my view she didn’t (while Fed Vice Chairman Stanley Fischer did), though plenty of others disagree. But focusing on this issue singularly misses a larger consensus building within the global central bank community.
After Japan’s and Europe’s catastrophic experience with negative rates insofar as the impact on the financial sector is concerned, Yellen used her keynote address at Jackson Hole to essentially rule out negative rates as a U.S. monetary policy tool.
Like a good central banker, she did not swear off any policy tool; however, I believe she made it quite clear that the Fed is not really interested in negative rates for now. While the case for negative nominal rates is that they are just part of a long continuum of potential interest rate levels for real rate mavens out there, the collateral consequences of negative nominal rates has proved to be quite problematic for global policy makers. Since these policy makers rely on the financial sector to implement their interest rate policies, the negative impact on the viability of the financial sector in a negative nominal rate environment is just too scary for them to deal with.
Negative Rates Off the Table
Yellen and her Fed cohorts are quite scared that if they are not clear in their communications on the negative rate front, and if the U.S. economy were to take a negative turn-which is not at all out the question in the current environment-bank stocks will be the biggest victim. That, in turn, could trigger a banking crisis for no good reason. And that is just too large a risk for them to take.
Being among the practitioners whose decisions affect the lives and portfolios of hundreds of millions of people — as opposed to theoreticians and academics — I agree that is the prudent thing to do. The benefits of negative interest rates are marginal while the costs could potentially be huge. The risk-reward profile of negative rates is very different from that of other policy tools such as quantitative easing.
So, negative rates are off the table in the U.S. for now. That, in turn, in my opinion, should bode well for financials, a deep value sector at the moment, which can’t catch a break on the regulatory or sentiment front. While financials have rebounded significantly off their lows earlier in the year, post-Brexit and European Central Bank bond buying programs, they still remain quite cheap.
Bank equities or bonds, anyone?
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