Tuesday,June 25,2019

Interest rates and the Great Recession


Interest rates and the Great Recession

The appeal of global bonds, So a recent article published by a manager of a major American investment fund was called. The conclusion was obvious anyway: fixed income, especially the sovereign, was doing much better than the stock market.

In his opinion, “he was performing hedge” against equities.Naturally, we speak of a fixed income manager and in a context, we eight years of almost uninterrupted fall in the profitability of this role in the medium and long term, very favorable.

However, not everyone is so convinced that with the current historical minimum profitability and negative territory in real terms, bonds are a good investment in the future. And much less in terms of coverage of other assets, considering the high risk premiums in the case of the bags. My opinion? I’m neutral, naturally. But within that neutrality, I can be objective.

That forced objectivity leads me to wonder to what extent the interest rates of sovereign debt risk premiums would be so low without the ultra expansionary central bank measures. And not only with respect to almost zero of official interest rates and the asset purchase policy levels. fixed income, especially.

In the end, influence interest rates in the short term and in the long term. This breaks an old unwritten rule in the markets: the official interest rates are set by central banks, while interest rates on medium and long term fix them corresponds to markets.However, it is true that central banks have thus become an investor more. Market share.

But you can also see it another way: simply central banks have taken exceptional decisions to restore the monetary transmission channel. And here we talked about private banks, in the process of adaptation to the stage (more regulation, heightened competition and economic weakness) and settings (NPAs) pending. In the end, for example, the ECB would have tried various expansionary measures taken to improve the financial conditions of households and businesses in a context of credit restriction. But what really was the credit supply problem?

How banks can be funded? Through money market deposits and borrowing.

Our empirical analysis broadly supports four of the five theoretical Implications of our model. First, Both the bank deposit rate and the lending rate Respond to money market uncertainty, and banks widen the spread Between lending rates and deposit rates to Compensate for the higher refinancing Risks in money markets. Second, higher risk of default on the loan leads to higher bank lending rates.Third, Those With access to banks money markets, and THUS banks relied less on ECB That financing, deposit rates offered Preferred lower and lower bank lending rates During the Great Recession period. Fourth, banks chose to finance That debt via lower deposit rates offered Preferred Both lending and lower rates.

How to understand the measures introduced by the ECB?

  • 1. It introduced measures to reduce the volatility in the money market: it became repo auction direct and total allotment of funds, extended the period of liquidity measures and expanded the collateral role in these injections
  • 2. The ECB took steps to reduce tensions in the debt market, as buying assets
  • 3. dissociated himself the credit risk of credit institutions illiquidity risk, while demanding greater strength and resistance balance

But at this point, we observed that the total credit (banking and wholesale) maintains marginal growth while there is suspicion about the distortion of these measures on prices of financial assets. Undoubtedly, the ECB measures (really major central banks) have been effective to avoid the risk of a prolonged recession accompanied by deflation.

But now what? Perhaps the Fed can help us answer this question today after the two-day FOMC. However, we do know the answer BOJ after today’s decision: refine and reorient the expansionary measures. Clarify them in terms of objectives desligarlas amounts (but the inflation target of 2.0% is maintained) and redirect it to try to avoid further distortion of interest rates in the medium term.

In short, try to put a floor at near zero levels. And it is no small thing, considering that for example in Europe public debt with interest rates negative and exceeds more than half of the emitted.In my opinion, these measures should not be interpreted as the end of the expansionary monetary policy. But, yes, as a first indication that aims to combat potential distorting effects on markets. And on the financial sector. Good news indeed.