Vimal Gor: the outlook for negative rates

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What’s the outlook for negative rates? Pendal’s Head of Bond, Income and Defensive Strategies Vimal Gor gives a snapshot here in a new video interview with online business channel

Watch the video above or read the transcript below.



AUSBIZ.COM.AU INTERVIEWER: Is the Fed continuing to backstop equity markets going to end in tears at some point in your view?

VIMAL GOR: Yes. I don’t think this negative rates thing is about back-stopping equity markets. I think it’s more borne out of necessity.

The problem the Fed has is that interest rates are at zero, 10-year Treasury is, call it 50 basis points, and we’re going to enter into a period of quite pronounced deflation in the US economy.

And that’s because the inflation rate is largely driven by the economic cycle.

We know the economic cycle is being curtailed because of what’s happened with the virus. So we’re going to have deflation in the US of somewhere between 2 per cent and 4 per cent over the coming months.

The problem is when nominal interest rates are at zero and you get deflation, it means you get rising real yields.

Now the economy is driven by real yields, not nominal yields.

So the problem is we’re in this terrible situation where we’ve got really weak growth and we’re going to see rising interest rates in the US.

So the Fed needs to counter that somehow. But the problem is they have limited tools now.

They’d like quantitative easing, but as I said, 10-year Treasury are only 50 basis points and moving them to zero is going to do largely nothing.

They’re doing all this funky stuff. We’re buying ETFs and high yields and stuff, but that’s largely trying to throw a lot of liquidity at what is ultimately going to be a solvency issue.

So now they’re thinking about cutting interest rates negative. And I think it’s a great idea and they should do it the way Rogoff talked about it in his Project Syndicate article over the weekend.

They should do a short, sharp shock that would take rates to -2 per cent or -3 per cent quickly and force the financial institutions to have to deal with it.

They need the banks to be ready and the banks in the US are not ready. But I’m sure they’re working with the banks to make them ready, were this to become an eventuality.

INTERVIEWER: One of those tools they do have left in their arsenal is just rhetoric and the mouthpiece. And that’s what the Fed’s (Federal Reserve Chair Jerome H) Powell has effectively been trying to do — push that message onto Congress: ‘We want that fiscal assistance’. He’s doing everything in his power, it would seem, verbally to avoid those negative rates. Just how long can he keep trying to play that game?

VIMAL GOR: I think Powell has zero credibility left now anyway. Yes, we need fiscal. But fiscal is, as I said, a stop gap. It’s a liquidity issue that isn’t going to affect the long-term solvency of these companies. They’re still going to go under.

Also how much more fiscal can we do? Yes, there’ll be an infrastructure package and yes there’ll be a few more after it, but we’re already staring down the barrel of budget deficits of 20 per cent in the US.

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You can throw more money after it again and again and again, but it’s the same old thing. We have this growing problem in the US since the GFC around quantitative easing, pushing up financial assets and benefitting Wall Street but not helping Main Street.

And they’re doing the same again. That’s what’s happening now. You’ve got unemployment north of 15 per cent, heading to 20 per cent in the US, and the S&P is not far off all-time highs.

This disparity needs addressing at some point.

By doing negative interest rates it actually helps Main Street and it kind of hurts the richer demographic part of the population. So it works on a number of levels.

Obviously the lobby groups and the banks will be strongly against it and people will have a tough time getting their head around it.

But ultimately when you realise that real yields in the US have been positive and negative a lot of times over the last 50 years, it’s not that much of a departure anyway.

INTERVIEWER: Donald Trump, the US president, would be happy to hear your reasoning on negative interest rates. He’s definitely in the pro camp. What’s a time-frame? You say that it should be done in a snap reaction, get things going, get things moving. So when are we likely then to see this coming to fruition?

VIMAL GOR: Well we’re going to see the unemployment numbers get worse in the short term. We’re going to see the inflation numbers — we saw CPI this week which was bad. We’re going to see that get materially worse over the next few months.

So the time is now. Whether operationally they can move before year-end I’m not too sure. The RBNZ gave the banks till the year end to fix their problems with operation and be able to handle negative interest rates. It doesn’t mean they can’t pre-announce though.

Ultimately whether the Fed does move to or not, the fact that they’re considering it is what’s important here, because the markets will now start pricing it.

As we saw this week, that markets started pricing negative interest rates already in the US and that opens up a part of the distribution that hasn’t existed before.

So therefore now it means the market will now price positive and negative interest rates.

Whether the Fed actually delivers on them or not — it’s important, but the market was already starting to price it. So that’s a really key thing.

The fact they’re having these discussions is material and given the fact that they didn’t want to counter the idea of negative rates just a few months ago.

The way they introduced negative rates in Europe, Japan — they did it incorrectly with hindsight. They did it too slowly and they did it too weakly, too slowly.

They cut rates a small amount sub-zero, then they increased it a little bit, a little bit, a little bit. You don’t deal with the underlying malaise in the economy and therefore you get the problem still there.

You get the back-end of the curve rallying, the yield curve flattens, which crunches your banks and it destroys credit creation. It makes the problem worse.

But if you’re to go in and move interest rates quickly and materially negative, we should hopefully not have those problems because you force the banks and financial institutions to lend money.

Which is ultimately the whole point of negative interest rates.

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