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Tags: ecb | investors | stocks | markets

Negative Rates Carry Many Risks, Known and Unknown

Negative Rates Carry Many Risks, Known and Unknown

By    |   Friday, 11 March 2016 10:40 AM EST

The ECB’s easing was obviously designed to be more than the market had expected without imposing more of a burden on the banking sector.

There is at least recognition of the fact that negative interest rates are a tax on the banking system.

Nevertheless, the ECB seems to be unable to tear the negative interest rate in the way other central banks have done, perhaps because of the incomplete nature of the banking union in the euro area, and therefore additional funding was offered in the form of the TLTRO, or the longer-term refinancing operations.

But, from a global perspective, what has Mario Draghi really done? 

Economically speaking we must say his measures have only a limited impact as:

  • Bank lending was already rising
  • Deflation is a media myth and not an economic reality
  • Growth in the euro area is above trend

However, the one thing that is important “globally is the "extra" body blow Draghi has delivered against the forces of globalization.

Yes, this is important and global long-term investors could do well paying attention to it because recently we already have been witnessing a collapse of globalization in global capital flows hosing the rise of home country or home region bias in overall flows.

Increasing the TLTRO that stands for “Targeted Longer-Term Refinancing Operations, and by which the ECB provides financing to eurozone banks.
Under the newly established ECB rules the TLTRO is basically a form of “capital control,” albeit a capital control that relies on market forces to deliver it.

The TLTRO gives cheap funding to banks that are willing to lend to whom ever they like as long as they are euro area corporates or households. This is a direct incentive not to lend overseas, to bias the structure of capital flows into the euro area and it is of course a major incentive to increase home capital bias and restrict capital flows therefore.

Now, one should not overlook the fact the euro area is a “capital account deficit” union of countries and at the same time a “current account surplus” union of countries.

The price of the euro is therefore determined, or at least for a big part, by the price at which European investors are prepared to put capital overseas, and again, this is important for long-term investors, both to signal the effect and the reality of Draghi’s additional capital control will be working against the idea of a further weakening of the euro.

Besides all that on the European continent we have on Sunday, March 13 in Germany state elections in the states of Baden-Württemberg, the Rhineland-Palatinate state and the Saxony-Anhalt state.

Of course, economics is global while politics is local and local politics is normally really local.

However, on this occasion the politics in Germany could be a bit more global in its importance as a barometer of sentiment.

So far, we have already contemplated “Grexit,” which stands for a Greek exit from the eurozone, now we are contemplating “Brexit,” which stands for Britain leaving the European Union, and then there is a growing concern among investors about the possibility of a “Mexit,” which stands for German Chancellor Merkel exiting the political stage.

No doubt, these election results could have a bearing on asset markets next week.

In the United States we have today, economically speaking of course, important export prices. These are important to economists although they are all too often overlooked by investors because they hint at the true real economic impact or the lack of the true real economic impact from the gyrations of the currency markets.

With the dollar weakening against the euro this could be pertinent. It certainly suggests further increase in U.S. export prices in time and with a potentially improvement in the nominal, but not necessarily in the real measures of U.S. manufacturing sector activity.

Finally, investors shouldn't overlook the fact that negative rates imposed by central banks imply many known and unknown risks.

Fitch ratings has warned negative interest rates in Japan will add further pressure on the Japanese banking sector’s already thin net interest margins.

On the ECB's action the big question remains whether investors, finance ministers or other central bankers ultimately end up believing Draghi.

I don’t think this is coincidence but overnight Japan's Finance Minister Taro was on the wires implicitly urging the Bank of Japan (BOJ) to take more action, which is really interesting when we look at it in the context of the recent reported criticism of Japanese policy at the G-20 meeting and precisely only a couple of hours after the ECB's own move …

Etienne "Hans" Parisis is a bank economist who has advised global billionaires and governments on the financial markets and international investments. To read more of his articles, GO HERE NOW.

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Investors should not overlook the fact that negative rates imposed by central banks imply many known and unknown risks.
ecb, investors, stocks, markets
Friday, 11 March 2016 10:40 AM
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