Is Gold The Beneficiary Of NIRP?

Negative interest rates are probably the hottest topic in monetary policy and financial markets right now. What do they mean for the gold market?

NIRP, NIRP Everywhere

Investors are afraid that negative interest rates could destabilize the global financial system. Until recently, they could consider NIRP as a European curiosity. But NIRP is becoming more popular outside Europe. The Bank of Japan introduced negative interest rates in January 2016. Now, over 20 percent of the world’s GDP is covered by the negative rate policy. On February 11, 2016, the Riksbank decided to cut the repo rate by 0.15 percentage points to -0.50 percent. According to analysts, Norway, Czech Republic and Canada may be the next countries implementing NIRP. Bank of Canada Governor Stephen Poloz said that negative interest rates are unlikely, but they could be used in a crisis scenario. He simply believes that the next global crisis is an unlikely event. However, financial crises are always unlikely… until they happen.

NIRP as Act of Desperation

The impact of negative interest rates in Japan should not be significant, however, they are interpreted as an act of desperation. It is perhaps best seen in the case of the Fed. Last week, Yellen was asked by Representatives and Senators whether the Fed considered the introduction of NIRP if things went south. Therefore, in some sense, she just had to admit that, indeed, the U.S. central bank was evaluating them, keeping the finger on the pulse. However, as we pointed out on Friday, when Yellen said: “we are taking a look at them again, because we would want to be prepared in the event that we needed to add accommodation,” investors heard something like that: “The situation is so bad, that we are considering even such a crazy idea as NIRP. We are obviously out of ammunition and we have no idea what to do.” It is a totally natural reaction, given that the Fed raised interest rates in December. If the U.S. central bank is now considering NIRP, i.e. is not decisively rejecting the whole idea, it could mean that it made a mistake raising interest rates two months ago and the U.S. economy is much weaker than they had believed.

Negative Interest Rates in Bank Stress Tests

Moreover, it is not only Yellen’s idle talk that worries investors. According to the Fed’s press release from January 28, 2016, the U.S. central bank required banks to consider a scenario in which the interest rate on the three-month U.S. Treasury bill becomes negative in the second quarter of 2016 and then declines to -0.5%, remaining at that level until the first quarter of 2019. Interestingly, the high inflation scenario from the previous year’s version was removed. Undoubtedly, including in a stress test a hypothetical scenario of a severe recession that precipitates a ‘flight to safety’ driving Treasury yields below zero is something different that a deliberate Fed policy of negative interest rates. However, disgust remains and we bet dollars to doughnuts that the U.S. central bank would not be entirely against reducing its target rate below zero if the economy unexpectedly weakened dramatically.

Conclusions

The bottom line is that NIRP is spreading around the world. Very well for gold! The yellow metal is perhaps the biggest winner of the current hype about NIRP. It’s not surprising given the inverse relationship between the price of gold and (real) interest rates. When interest rates are lower, gold, as it does not bear any yield, looks relatively more attractive. However, there is something more than that. Negative interest rates are seen as proof that the recent monetary stimulus was ineffective. Moreover, negative interest rates are in an uncharted monetary territory with uncertain long-term effects (remember fears about quantitative easing?). This could harm profit margins in the financial sector and destabilize the financial system. In consequence, concerns about the inherently unstable financial system should increase the safe-haven demand for gold. Consequently, gold might move higher in the coming months, but we can't say much about the coming weeks based on the above analysis alone.