As 1980 adoption of Supply Side economics was replaced in favor of Keynesian stimulus by many nations due to the 2008 crisis, interest rates in 10 nations from 2008- 2009 experienced not only the largest collapse year over year since the crisis at a negative rate of change of 24.94% , minus 19.72% year over year but the downward trajectory continued to present day. Easily arguable is interest rates peaked from the 2003 – 2006 economic boom because of the 2007 – 2008 minus 20.93% rate of change and minus 3.581% plummet year over year. Viewed from 2014 – 2015, the negative rate of change was approximately 40% of the 2008 – 2009 depreciation and minus 8.58% year over year. The violent reductions were seen specifically as 2008 – 2009 experienced a 20 index point plunge while 2014 – 2015 lost nine points. Year 2008 was a turning point for markets and central banks as the policy choice dilemma was stimulus or adjust for the future.
As regressive stimulus policy was chosen and viewed from the January 1972 free float separated by four quadrants with each quadrant valued at 12.5 years, 2008 was the demarcation line of the 3rd and 4th quadrant. Stimulus policy expedited markets into the current 4th and final quadrant. Since 1694 and Bank of England establishment as the world’s first central bank followed by Scotland in 1695, its customary and traditional for central banks to adopt questionable 4th quadrant policies to last to the final 50th year when a new market period highlighted by prosperity reigns. Sir Isaac Newton began cycles and quadrants when as Chancellor of the Exchequer overvalued Gold in relation to Silver in 1717. Further 50 year market periods 1770 -1820, 1820 – 1870, 1870 – 1920 and Gold wars of the 1960’s were characterized based on Gold’s fixed valuations. Why 4th quadrant policies are generally questionable is because of traditional 2nd quadrant market crashes. New policy prescriptions are implemented in 4th quadrants as third quadrant corrections end from 2nd quadrant crashes.
A 10 supra national Simple Interest Rate index was constructed to determine not only the current economic context but interest rate situation particularly as it relates to the five negative interest rate nations. The 10 nation supra national index includes Switzerland, Europe, Japan, Sweden, Norway, United States, UK, New Zealand, Australia and Canada. Interest rates include Saron -Switzerland, Eonia – Europe, OCR – New Zealand, OCR -Australia, Call Rates -Japan, Stibor – Sweden, NOWA – Norway, Fed Funds – United States, Sonia- UK and Corra – Canada. Negative interest rate nation Denmark was slated as the 11th cohort but the Denmark Central bank in cooperation with the Danish Bankers Association is in transition to transfer Tom/Next data responsibilities to NASDAQ OMX. Current data rather than historic was a severe problem to obtain. Negative interest rate supra nationals include Switzerland, Europe, Japan, Sweden.
Monthly data was aggregated from January 2007 – January 2015 for each index component and calculated as simple moving averages recorded in successive order from 1 – 9 years for each nation, a total of 90 moving averages. Data points total 1080, 108 monthly averages for each nation. As a Simple Index, 2007 was the base year to view specifically 2008 – 2015. Overnight interest rates constitute the commonality amongst index component interest rates.
As many nations abandoned Libor Fix participation, central banks began a long arduous process to review national commonalities to revamp overnight rates. Traditional overnight rates were set low to both balance end of day bank surpluses and deficits but also to gain competitive advantge in other nations’ markets. Why overnight rates is due to disjunctions between and among nations in specific markets. UK and the United States for example lacks a 60 day maturity relationship while New Zealand and Australia is void in the 1 year maturity connection. The most important consideration to revamp overnight rates was re-establish corridor systems inside respective nations markets as well as between and among nations.
The ECB corridor from Eonia to the Refinance Rate was traditionally set at 75 basis points post 2008, 100 bps since Euro introduction but due to four Eonia reductions from June 2014 to current day, the corridor is today 60 bps. Further current corridors: US from Fed Funds to headline is 14 bps and 77 bps from Eonia to Fed Funds. Japan to Europe is measured at 30 bps and 47 bps to Fed Funds. Australia and New Zealand share a 25 bps relationship, 77 and 88 bps from Fed Funds. Inside Australia, the corridor is five bps and eight for New Zealand. Swiss to Europe allocates 30 bps , 30 bps to Sweden, 20 bps to Canada, 1.07 to Fed Funds. The UK to Europe corridor is 80 bps, 9 bps to Fed Funds and four inside the UK. Not only did interest rates peak in 2007 but corridor compression is the result of adoption of Silvio Gesell’s first time implementation of negative interest rate experiments.
Based on Gesell’s 1906 “Natural Economic Order” and 1891 “Reformation of Coinage as a Bridge to the Social State”, central bank policy delineates three factors of Gesell: stop the rate of interest growth, contol money velocity and stop exchange rate appreciation. Velocity is key especially as money is directed inside small corridors. If money supply velocity is measured as GDP divided by monies in circulation then the object to money circulation is to channel money inside smaller corridors. Economically, velocity equalizes goods and money relationships to determine prices and stabilize purchasing power. Money is stagnated by rates of interest growth and if removed, GDP would rise quickly to the point negative interest would be justified. Gesell views interest rates in reverse order as prices drive interest rates rather than rises and falls in money supplies.
A further policy to ensure money direction inside corridors is to eliminate interest rate maturities then connect remainder interest rate categories to an interest rate Fix based on volume. The ECB constituted 15 maturities upon Euro introduction then eight in 2013 and five maturities will be offered July 1. The Federal Reserve adopted volume weighted medians March 1. Consolidated maturities allows future interest rate rises and reductions to normalize expeditiously. The ECB for example normalizes many months post rate rises or falls while New Zealand and Australia normalize within days. The downside to consolidated maturities and volume Fixes are ability to control and slow volatility.
As 2008 – 2009 experienced negative rates of change of 24.94% and minus 19.72% year over year, overnight rates continued a slower rate of change decline until 2014 – 2015 accomplished negative 19.02% rate of change and minus 8.58% actual year over year. The ECB was first in June 2014 to slash Eonia to zero then entered negative territory September 2014 followed by the Swiss in December 2014 and Sweden Q1 2015. Canada reduced Corra January 2015 while New Zealand dropped OCR from January 2008 at 8.25% to current 2.25%. While rates of change slowed from 2008 – 2014, actual year over year changes maintained a steady rate of decrease as 2012 -2015 achieved minus 30.23% collectively yet the full contraction began aggressively again in 2011 from 2008 minus 33.23% and negative 19.72%.
The mean of the 2007 base period was 1.7109 and consistent as measured against forward rates year over year although seven year rates calculated six years forward at 1.9762 lacks synchronicity to remainder yearly maturities. Correct forward curves are smooth and ordered maturities alongside sufficient distance to allow trades between rates. An out of sync maturity alters curve dynamics. Year 2010 as the six year rate experienced an increase in yearly averages, index values and stagnant rates of change. Rates of change and year over year values were factored to 0.64% and 0.39%. The two year rate, 1 year forward, three year rate 2 years forward and four year rate, three years forward factor to 1.9317, 1.9392 and 2.12. The enormity of the eight to nine year rate of change of 33.23% is viewed from the eight year rate, seven years forward at 6.95 and the precipitious drop seen seven years later to current 1.9317.
Descending forward rate lines means a huge hurdle must be overcome if ever interest rates change course and rise. In volatile and uncertain interest rate markets, ability to lock in forwards for future dates becomes harder to pinpoint the correct tradeable maturity. Hedges must adjust constantly.
The Carry Trade measured from high to low mean index values and calculated to foreign exchange pips reveal 10,860 pips were lost since 2007, 7279 since 2008 and under the current 11,679 mid point. The index began in 2007 at 17109 pips and ended January 2015 at 6249. In actual yearly pips lost, 2015 experienced the sharpest decline at 1080 pips. In 44 years of currency trading since the January 1972 free float in monthly averages, 18 years reveal 1000 pip or more years and 10 years experienced 1500 pips or more. Falling interest and exchange rates lends uncertainty to carry trades as a steady source of income, currency value appreciation and yield gain.
Aggregate weights were calculated year over year to confirm not only the divison between the 6 and 7 year maturities but also confirms the downslope year over year. Aggregate weights rarely hold enormous tradable revelations however weights provide insights to positions and possible adjustments as the Simple Index is oversold while aggregate weights lean towards overbought. The monitor for the future is possible base effects or at least a slower rate of change as aggregate weights reveal 1.2349 from year 2015.
Among the five negative interest rate nations, Swiss Saron is negative to the seven year average while Eonia is negative to the three year. Stibor is negative to the one year average while Norway and Japan remain positive from 1 – 9 years. Denmark’s Tom /Next rates as speculation based on compiled data is negative to the four or five year average.
As Quantitative Easing met Keynesian liquidity traps when interest rates attained zero and intended economic effects failed to materialize, negative interest adoption appears as a new method in continuation of the 2007 peak. Negative interest is a break of the positive zero point as ranges encompass 0.0 – 1.0. While zero is the bottom, negative zero represents catastrophic collapse because money would achieve negative value. As ranges, Sweden and the ECB remain middle bound while Japan and Norway are top of the range. Denmark and Switzerland are located at bottom ranges.
The crisis and precipitious drop in 2009 – 2008 offered downside trend momentum. Central banks not only adopted Gesell’s negative interest rate theories but follow Gesell explicitly in terms of exchange rate depreciation, slow interest rate of growth and channel money velocities. The current period represents implementation yet the future question once interest rates bottom and reverse course is how to view quantatitive easing or will central banks revert to supply side policies by addition and subtraction of daily money to balance the system. This question assumes success in current implementation. Negative interest is not only here to stay for the foreseeable future until Inflation targets are achieved but more central banks are expected to adopt negative interest rates to remain competitive. Norway, Bulgaria, Czech Republic and Isreal are possible candidates.
Brian Twomey, Inside the Currency Market, btwomey.com