Negative Interest Rates Already in Fed’s Official Scenario

But forget QE-4.

The Germans, with Teutonic precision, call them “Punishment Interest.” Negative interest rates are spreading from the ECB’s negative deposit rate across the bond market and to some savings accounts in the Eurozone. The idea is to enrich existing bond holders and flog savers until their mood improves. Stock prices are allowed to get crushed by reality.

Negative interest rates destroy one of the most essential mechanisms in an economy: the pricing of risk. Investors end up taking huge risks with no reward. Many of them will get cleaned out down the road.

In Switzerland, punishment interest already causes “perverse unpredictable effects,” as mortgage rates have started to soar. It’s wreaking havoc in Denmark and Sweden. Bank of Canada Governor Stephen Poloz let the idea float that he’d unleash punishment interest to destroy the Canadian dollar. The Bank of Japan announced Friday morning – timed for maximum market effect – that it too would inflict negative interest rates on its subjects.

In the US, Ben Bernanke has been out there preaching to the choir about them. Over-indebted corporate America, except for the banks, would love this absurdity; it would allow them to actually make money off their mountain of debt.

“Potentially anything – including negative interest rates – would be on the table,” Fed Chair Janet Yellen told a House of Representatives committee in early November.

Fed Vice Chair Stanley Fischer has been publicly obsessing about them for a while. Monday, during the Q&A after his speech at the Council on Foreign Relations, he said that negative interest rates are “working more than I can say I expected in 2012.”

It seems to be just talk. But negative interest rates are already baked into the official scenario for 2016. It’s in the Board of Governors’ new report on the three scenarios to be used in 2016 for the annual stress test that large banks are required to undergo under the Dodd-Frank Act and the Capital Plan Rule.

The scenarios – baseline, adverse, and severely adverse – start in the first quarter 2016 and also include economic factors in the Eurozone, the UK, Japan, and the weighted aggregate of China, India, South Korea, Hong Kong, and Taiwan.

In the “severely adverse scenario,” things get interesting.

But don’t worry, the Fed emphasizes that “this is a hypothetical scenario” for the purpose of a bank stress test and “does not represent a forecast of the Federal Reserve”:

The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities.

GDP begins to tank in Q1 2016 and by Q1 2017 is 6.25% below pre-recession peak. The unemployment rate hits 10% by mid-2017. Headline CPI rises from an annual rate of 0.25% in Q1 2016 to 1.25% by the end of the recession. Asset prices “drop sharply,” with stocks down “approximately 50%” through the end of this year, accompanied by a surge in volatility, “which approaches the levels attained in 2008.” Through Q2 2018, home prices plunge 25%, commercial real estate prices 30%.

“Corporate financial conditions are stressed severely, reflecting mounting credit losses, heightened investor risk aversion, and strained market liquidity conditions.” Bond spreads blow out, with the yield spread between investment-grade corporates and Treasuries jumping to 5.75% by the end of 2016.

So things are going to get ugly. And here is what the Fed is going to do next:

As a result of the severe decline in real activity and subdued inflation, short-term Treasury rates fall to negative ½ percent by mid-2016 and remain at that level through the end of the scenario.

Short-term Treasury rates can only fall to a negative 0.5% if the fed funds rate is at that level.

And the whole yield curve comes down, with the 10-year Treasury yield collapsing to 0.25% by the end of this quarter, but then “rising gradually” all the way to a whopping 0.75% by the end of the recession and to 1.75% by Q1 2019 (it’s 1.93% now).

The international component “features severe recessions” in the Eurozone, the UK, and Japan, and a mild recession in developing Asia, along with a “pronounced decline in consumer prices.”

Due to “flight-to-safety capital flows,” the dollar appreciates against the euro, the pound, and the currencies of developing Asia, but will “depreciate modestly” against the yen, “also in line with flight-to-safety capital flows.”

One of the differences between the severely adverse scenarios for 2015 and 2016? The scenario this year “features a path of negative short-term U.S. Treasury rates.”

Who are the winners? Existing holders of long-term Treasuries who will benefit from “larger gains on the existing portfolio of these securities.”

However, the Fed makes no promises about stocks, having seen the debacle playing out in Europe where stocks have plunged despite negative interest rates. And banks will get hit as “negative short-term rates may be expected to reduce banks’ net interest margins and ultimately, to lower PPNR [pre-provision net revenue].

And there you have it. The Fed already has a “path” to negative interest rates.

But note: not a single word about QE.

If the stock market crashes 50% this year, as the “severely adverse” scenario spells out, all the Fed will do is slash the fed funds rate to a negative 0.5%. And if stocks crash only 25% this year, instead of 50%?

That’s the case in the Fed’s middle scenario, the merely “adverse” scenario. Short-term rates will “remain near zero” it says – maybe slightly below where they’re right now. So no negative interest rates. And no QE either. Stocks can go to heck, the Fed is saying. It’s worried about credits, particularly high-grade credits. Junk bonds and stocks are on their own.

And this concept of switching to negative interest rates and away from QE is even in line with the Bank of Japan’s desperate head fake. Read…  QE in Japan Nears End: Daiwa Capital Markets

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  38 comments for “Negative Interest Rates Already in Fed’s Official Scenario

  1. Mick says:

    I’ve known they won’t do QE again since they ended QE3. How?

    Wave theory.

    This is what is ACTUALLY in control of all markets, not the FED. Yeah, yeah, I know, the FED pumped the market with QE.

    To this I say; If the FED is so all powerful, why did it wait until the market had completely bottomed out in 2009 before launching QE?

    Why not launch it in the summer of 2008 when everyone knew the market was going to crash?

    Would that have been a better time to “save the day”?
    Answer; Because the FED isn’t all powerful, and they know it.

    Wave theory forecasts stock markets to fall hard and for years, regardless of what the FED does.
    And what a coincidence, the FED has “decided not to discuss QE4.”

    That’s right, cause it wouldnt work.

  2. Bob Miller says:

    Went to a new school. The first or second day there a boy sitting beside me warned me about a boy in the class who required a payment each day of $0.10 or he’d beat you up. At the first recess I walked over to this tough guy and hit him hard in the stomach. I said, “I can’t afford the $0.10 so I’ll give one of these everyday instead.” Bankers and politicians know exactly the type of people they’re dealing with and act accordingly. The chains of servitude and submission are passed down from one generation to the next. “Son, just be thankful for a full gut and a roof over your head. Money can’t buy happiness.” As if poverty could.

    • Robert says:

      That was very good, Bob. I tried to reason with the manager at my bank:
      “You charge cardholders 20% APR- I should at least get something for my act of deferred gratification, don’t you think?” When he said “Sorry,” I told him I was closing my account and moving it to a credit union- they don’t pay much, but at least none of their executives are getting million-dollar bonuses. On the way out the door, I told him, “The lack of interest is mutual.”

      • Bob Miller says:

        I feel a strong need to say, “Thank you.” Being retired military I get to bank at USAA. They can’t do enough for us. We wouldn’t have to fire a shot to have the Fed and Congress eating out of our hands. Only one thing would be needed, the thing the Federalist and those who have come after them, fear the most. We arrive at their doorstep ten million strong.

  3. Dan Romig says:

    Stocks could fall quite a bit this year, but the ZIRP and NIRP absurdity are certainly having an effect on equity values. As measured by the Shiller 10 year PE of the S&P 500 we are at 24.6, and the historical number is 16.7.

    Could the S&P 500 drop to 1300?

  4. Petunia says:

    By call them negative interest rates you obscure the fact that they are confiscating our money. They did it in the bailout by passing the cost to us, and then taking our houses anyway. Then they recapitalized the banks at our expense thru QE, by purchasing their junk at face value. Of course they plan to take more, what they have done in the past is called a clue.

    • Robert says:

      The real reason the banks are trying to go cashless is to prevent the inevitable wave of bank robberies: what jury would convict a fellow, who in his defense said, “I wasn’t robbing them, it was just a temporary bail-in.”

      • Petunia says:

        They may go cashless, but they are only going to make other currencies more valuable. The only thing necessary for script to have value is for people to trade their labor and their goods for it. At that point people might trade with anything other than credits.

        As an aside, living in Florida is a window into how people function “outside” the system. The immigrant community functions with one foot in the system and one foot out of it. Someone in the family may be on the books while the rest are off the books. They milk the system for whatever they can get. Somebody has a bank account and the rest don’t want one. Somebody owns the house, the rest will participate in its sale eventually. They are used to using currencies from different countries and have no aversion to holding it. I could by stuff with Mexican pesos, or any other currency, if I gave them a big enough premium. They wouldn’t even be surprised. It is like a parallel universe the rest of America doesn’t see.

        • david says:

          They better be careful going cashless with the worlds reserve currency. With mega dollars overseas they could all dump for a more liquid currency, thus further killing the dollar. Or could it be they are just clueless theoretician academics that really have no idea what they are doing?

  5. unit472 says:

    NIRP is very confusing if not irrational. It makes debt more valuable than cash doesn’t it? If I get a 30 year mortgage at negative 4% the mortgage is self liquidating even if I make no payments!

    Maybe Ben Bernanke and his ilk can explain how this can possibly work?

    • Robert says:

      Ben will explain to you, if you’re lucky, that NIRP is only for the banks that own the Fed, not you. They still get to charge you 20+% on your credit card, plus extra charges and late fees that are anything but negative

  6. Vespa P200E says:

    “In Switzerland, punishment interest already causes “perverse unpredictable effects,” as mortgage rates have started to soar. It’s wreaking havoc in Denmark and Sweden. ”

    Alas – QE didn’t really work so global CB cabals out of pure desperation is experimenting beyond ZIRP to NIRP.

    But will NIRP stimulate the spending and stop the deflation spiral ushering in the unintended inflation monster due to “competitive” currency devaluation and downright money printing (starting with small countries) with loss of faith in FIAT currency? History have shown that wars are started as way to divert the people’s discontent.

    We indeed live in dangerous times for our children to inherit the bleak future…

  7. ERG says:

    It doesn’t matter what they call it.

    Anything they put in place to hold up this sad joke of an economy will be yet another pipeline to drain the wallets of citizens.

  8. J P Frogbottom says:

    Negative interest rates are fine with me. I will continue to invest in dividend paying stocks when I can buy them on the cheap(er).

    The housing bubble showed us that the price paid for an item, may not reflect its value. I had a mortgage during that time, on a home I built in 1997. While may initial fixed rate mortgage was 7.5% I tried to pay a bit extra each month, refinancing it several times at a lower fixed rate until the mortgage was paid off. While I was doing this, some of my friends were buying 2nd and 3rd homes, or taking ‘cash out’ refi’s. We all know how much of that ended. How many were surprised there?

    Am I correct? Who knows. If you intend to eat, drive, use utilities, in the future I shall assume I will be right. If you plan to live on the street, I may be wrong, but I probably will not join you. At least for awhile, until my investments reach zero.

    The economy is not great, but…

  9. Lars says:

    As in Astrophysics, the Mainstream became enamored with what multiplying and dividing by Zero could do for them, it engendered the existence of Neutron Stars and then Black Holes, it inferenced that the Universe was ‘expanding’ and then at an ‘accelerating rate’ of expansion. Unfortunately for Mainstream all 4 of the preceding concepts are TOTALLY FALSE (along with a basket full of other erroneous concepts that Mainstream subsequently promoted).

    Now, the Financial Sector is becoming enamored with what Zero will do for them in the Central Bank department, from Zero % lending rates to Big Institutions for the Yen and now Dollar Carry Trade. And in my estimation this NIRP trend is being predicated on their economic formulas saying that in order to make the horrendous overhanging monster of international Derivatives Contracts cancel out and disappear, they need to move interest rates to the magic number of the “square root of minus 1”.

    • Petunia says:

      Most people don’t understand that the “square root of minus 1” called an imaginary number, has a real definition in mathematics, and in modeling.
      Most people think of it as just an undefined/unquantifiable idea but it is not. An imaginary number describes the point on a trend line where trend changes direction, unpredictably. Your use of it regarding derivatives is correct. I always thought of it as the point in the trend line where the money disappears.

      • bud says:

        Petunia, you are very smart, nice to read your posts. Yes, you got Florida right but now it is everywhere.

        The banks, government, and corporations (as people) have been using imaginary numbers for years…seasonal adjustment, accounting gimmicks, and any other deception that is at hand to change the ‘trend line’ or make money disappear. Imaginary numbers don’t lie, their creators do.

        Children play that game, perhaps we are controlled by children who have not grown up to run headlong into the stark facts of reality…yet.

        Can it be that the FED sees the trend line running straight into ugly reality? Bits of the scenario seem to hint at that. Naa, to good to be true.

      • Jerry Bear says:

        As a mathematician I can state that there is no actual “square root of -1”. They are using certain complex numbers as proxies for real numbers and like all complex numbers they have well defined roots. Thus the “-1” they are finding the root of is really the complex number 1,180degrees. unfortunately, as complex numbers are usually presented they disguise this fact to the gross confusion of the students. A complex number is not really a vector either it is a spinor. a quantity having a fixed magnitude and a fixed rotation. In two dimensions, spinors and vectors look exactly the same (though their algebra is different) so vectors are used as proxies for complex numbers. If you want to know what a complex number is, it is just a combination of a length and an angle. It encapsulates the very essence of Euclidean Plane Geometry. Cartesian Coordinates can reduce complicated problems in geometry to algebra but complex numbers reduce them to arithmetic with huge efficiencies. They can also usually let you avoid the headaches of having to deal with trig functions. The whole technology of alternating current is based on using complex numbers to represent the currents. Length becomes amplitude and angle becomes phase but otherwise it is straightforward complex arithmetic.
        You can divide by zero, contrary to what you have been taught if you restrict your numbers to positive numbers and zero. If you divide a fixed finite amount by an ever shrinking amount the result gets larger and larger without limit and becomes infinite as the divisor approaches zero. A lot of Calculus is based on this sort of approach. Thus, using limit methods and excluding the negative numbers you can say that dividing a finite amount (neither infinite nor infinitesimal) by zero results in infinity. This is very visible in graphs.

  10. Ptb says:

    Everything is “on the table” as this is a desperate time for central banks. NIRP has been a reality since the savings rate has been far below 1%. T Bills and savings have been Essentially, parking places for money.

    One thing seems very consistent since the GFC in 2008, the Fed will do everything it can to preserve debt. The govt and the Fed understand that this is their life blood and must be preserved.

  11. Paulo says:

    I don’t think they’ll do it. An ‘Exceptional’ country with a ‘sound’ economy wouldn’t need to do something so drastic. Right?

    Well, I’ve got our savings in a credit union with 2.25% terms and GICs, with a small pension paying our day to day expenses and modest whims. If the return gets any worse I’ll buy a rental or some land. I’ll give the renter a deal provided he/she doesn’t claim any rental subsidies and just go ‘undeclared’ with the monthly payment.

    I do know this, the Govt and their banking buds can only squeeze so much out of us before we get some back. I need a personal ‘nest egg’ to feel secure, just like I need food, gardens, tools, and guns. If ‘they’ reach into my pocket for any more, our family will spend even less to make up for it.

    “They’ need to be aware of unintended consequences. If I hunker down…big deal. If many hunker down, it will become a movement that will starve the parasites. If ‘they’ double down to increase their blood sucking….time for pitchforks. It may just be enough to get Bernie elected as well.

    • Sandy says:

      Bernie is history. Hillary is almost inevitable. It’s reward time for Ms H. After all, she presided over the Benghazi bloodbath and didn’t blink an eye. The cabal will reward her.
      I do agree that they can only take so much…’s almost over, really. China ultimately will act and our $ will not be worth much. Then, the ESF will starve and the unlimited cash required to fund this monster squid will be gone. We, the people, will carry on and re-invent the US. Without them.

      • Nicko says:

        China will be increasingly distracted by their own population, as internal dissent and labor strikes mount. —another factor, China is losing their cheap manufacturing edge to regional rivals. Is it no wonder record hundreds of billions of dollars is fleeing China looking for safe harbors?

      • OutLookingIn says:

        America – H. Clinton or four years at Bernie’s place?


        Lets see. Fire or fry pan? Yup, that’s some choice. Then again it just might be the “Ring Master” of the MSM circus, (you’re fired) Donald.

        Then again, who am I to say. We just elected the “Kid” Trudeau!

  12. J P Frogbottom says:


    Since Bernie is so ‘despised’ by the big money Wall St. types it probably is time to elect him, depending on ‘who’ he would intend to surround himself as part of his team. Rubin, Summers, and Turbo Tax Timmy Geitner types would alter my views.

    • Paulo says:

      I really liked Bernie’s speech last night!! But then again, I’m just a socialist Canadian. :-)

    • VegasBob says:

      Well, there are 2 candidates in the race that do not support more trade agreements that are designed to further destroy the US economy and the standard of living of American workers.

      Those 2 would be Donald Trump and Bernie Sanders.

      Hillary Clinton is lying, as usual, when she says she no longer supports TPP. She was for it 44 times as Secretary of State.

      I’ll bet anyone a steak dinner that if that lying termagant Hillary is elected, she’ll introduce TPP in some form within 6 months of taking office.

      • bud says:

        IF the mess every one seems to agree on is staring us in the face, then why not let the chips fall on the family that brought us Graham-Rudman. Surely the relationship with all the ex golde’mites who run ALL the CBs can put Humpty Dumpty back together again with a little help from a friend.

        Besides Uncle Warren wants her elected. Now would it be fun to watch Uncle Warren and Charlie K do mud wrestling…..winner take all.

  13. Bobcat says:

    Negative interest rates, what a concept … sorta like used food.

  14. OutLookingIn says:

    ZERO interest, or more like the reality of negative return, has been the norm for a number of years now.

    We all know the government fudges the CPI lower than it really is, as it does most stats that show economic weakness. The REAL rate of price inflation is more like 9.0%

    So these “generous” banksters give you 2.25% on your savings. Factor in the REAL CPI rate and end up ‘sucking the wet end’ of a negative 6.75% return.

    A NIRP policy will force most into a physical “cash in hand” action and spur a bank run on physical (fed notes) cash. Little wonder the “cashless” society plan, is getting so much MSM air time! Hmmm…

  15. d'Cynic says:

    What about the theory that as ever wider sections of population realize that the lunatics are running the asylum, more people decide to run for the hills. The more the push lower, the scarier the wait for the crash becomes. Very bullish for the eCONomy.

  16. Curious Cat says:

    According to the National Taxpayers Union the bottom 50% of taxpayers pay only about 3% of the federal income tax. Some of us folks on this website have reasonable strategies to try to weather the coming storm. But I’d venture at least half of the population has no strategy. The other day I read that about 30% of Americans have less than $1,000 in savings. So when TSHTF, it’s not gonna be those who stole our money that we will need to worry about. It will be the folks who have not resources and still need to eat and feed their families.

  17. rich says:

    Real negative interest rates would crush pensions.

  18. Nick Rijn says:

    For an unsettling thought, think about what levels and types of activity might be seen from the lower-asset / lower income population after a 3 to 15 day outage of their EBT / SNAP / food stamp cards.

  19. Thaisleeze says:

    “I am convinced that there is no limit to measures for monetary easing,” he said. “The BOJ will do whatever we can to achieve the price stability target of 2 percent.”

    BOJ gov Kuroda in today’s Japan Times.

    And I am convinced a complete monetary reset is the end result, the only question is when and will it be forced by the markets or sprung on us on a Sunday night.

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