If you’ve been listening to the chatter around the Fed and interest rates lately, you’ve likely heard mention of negative interest rates. Now, before you say that I made that up, it is indeed a real thing. And while we don’t have them here (yet), they are a reality in some pretty big economies around the world. As of yet, the jury is still out as to whether they are achieving their goal. Let’s take a look.
A little background first. U.S. banks are required to hold a certain amount of money called a reserve requirement. This reserve requirement is based on the total amount of deposit liabilities they have and can be held either in the form of cash in a vault, or a deposit at the Federal Reserve. Over time, a bank’s reserve requirement will fluctuate which may cause it to have too much on deposit at the Fed. This is called an excess reserve. While held at the Fed, these deposits earn interest. As of 3/21/2016, the rate on required reserves and excess reserves at the Fed was the same: 0.50%. This type of system is similar around the developed world at most central banks.
Negative Interest Rate Policy (NIRP) is the strategy to combat deflation where a country’s central bank charges interest on the reserves they hold for their member banks, as opposed to paying them interest. The goal of this policy is to lower interest rates even more and encourage more lending. (Cheaper rates make it more attractive to borrow). More lending means more consumption and hopefully economic growth. This may seem like the natural extension of lowering interest rates to zero, and for the most part it is. NIRP comes with all the trepidations of other easing monetary policies (risk of hyper-inflation, negative effect on savers, etc.), but, there are some important differences.
At zero percent, these reserves can just sit at the central bank, not earning anything, but not costing anything either. At a negative rate, the banks have an extra incentive to put those funds elsewhere. This could drive the short term rates for institutional and retail customers from zero to negative. In essence, charging investors and savers to keep their money somewhere. This may cause savers to actually take their money out of banks if the costs become too high.
Also, if it costs money for banks to keep reserves, this will lower the margin and profitability on bank loans. This could actually disincent banks from loaning money (which is the exact opposite of NIRP’s intention).
Very important to our economy, is the effect it may have on the money market funds (MMF). To be clear, these are not the money market accounts held at banks or credit unions. These are investment funds that are run by money management companies. It has generally been accepted that regardless of the interest rate being paid (even zero), the value of a MMF share will remain at $1.00. If rates become negative, this arrangement could be in jeopardy and force MMF’s to close or trade below $1.00 per share (called “breaking the buck”). MMF’s are a major purchaser of short term debt instruments including commercial paper, which is used by many companies to fund short term obligations (such as inventory and payroll). If the commercial paper market is disrupted, this could adversely affect our economy.
Currently, both the European Central Bank (ECB) and the Bank of Japan (BOJ) have a NIRP in regards to their banks’ excess reserves. The ECB’s rate on excess reserves is -0.40%, and the BOJ’s is -0.10%. It’s important to note that the negative rate is just on the excess reserve. In theory, these funds can be taken out without affecting the reserve requirement. However, as of October 2015, the ECB held €352 billion in excess reserves* (it’s NIRP has been in place since mid 2014). The long term effects of NIRP are still unknown. And the deflationary forces in the Eurozone and Japan are still alive and well. It’s difficult to say whether this policy will accomplish its objective. But, as the world economy is seemingly slowing, and the US cannot exist in a vacuum, the discussion of further monetary easing in the U.S. has once again surfaced. And, this discussion definitely involves NIRP.
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Verity Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
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A Financial Advisor registered through CUSO Financial Services, L.P., Gavin has 25 years of experience as an advisor in the Puget Sound area.
“I believe every client is unique and deserving of a personalized financial plan that will help them reach their individual financial goals. Before I make any recommendations, I like to get to know my clients. By asking the right questions, and developing an honest, trusting relationship, I can really get a sense of what’s going to work best for them.”
Gavin graduated from the University of Washington with a BA in Business Administration and started his financial career with US Bank in the Investment Department. Prior to joining Verity in 2006, he spent eight years with Piper Jaffray.
So what is Gavin’s vision for his dream retirement?
“My dream retirement would be absolutely worry free: financially, emotionally, and in every aspect of life. My finances would be in order so expenses for travel, luxuries, and gifts for the kids, grandkids, and great-grandkids would be taken care of. My kids would be financially sound, so I would be confident in their prosperity. This would give me the freedom to travel and play and do whatever it is I want to do.”
When Gavin’s not working, he enjoys spending time with friends and family, watching Husky football and taking weekend trips around the Northwest.
Gavin is registered to transact securities business in the states of AZ, CA, CO, FL, HI, ID, IL, KS, MN, NV, NY, OR, UT, VA and WA.
*Non-deposit investment products and services are offered through CUSO Financial Services, LP (“CUSO Financial”) (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CUSO Financial. Verity Credit Union has contracted with CUSO Financial to make non-deposit investment products and services available to credit union members. Atria Wealth Solutions, Inc. (“Atria”) is not a broker-dealer or Registered Investment Advisor and does not provide advice. CUSO Financial is a subsidiary of Atria.
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