Friday, January 29, 2016

Bank of Canada Holds Overnight Rate at 0.5%, Following Multiple Cuts in 2015

Last week, the Bank of Canada announced it would stay at 0.5 percent for its target overnight rate (the equivalent of the Federal Funds Rate in the US).

Many had believed that the BOC was leaning toward another rate cut, but those seeking an additional cut to stimulate Canada's troubled economy were disappointed. The dropping oil price has heavily impacted Canada's economy, just as it has been taking its toll on oil-industry-heavy Western states in the US.

The overnight rate was cut twice in 2015. From 1.0 to 0.75 in January 2015 and again to 0.5 in July. While the recent hold-steady policy provides a respite from 2015's cuts, the overnight rate has been at very low levels since 2009. the BOC has been relatively hawkish compared to the Fed, although not by much:

Now, unless you count the EU as a whole, Canada remains the US's largest trading partner. (And Canada is one of Colorado's largest trading partners.) So what happens to the Canadian economy does indeed matter to American investors and consumers.

Fortunately for Canadians, and for Americans who are adept at investing in Canada, Canada's economy has been relatively stable in recent years. Canada avoided the a collapse in housing markets, and in the wake of the 2008 financial crisis, Canada was said to have "gotten things right."

Indeed, Canada's central bank had pursued easy money less aggressively than the US in the early years of what would become the US housing bubble, possibly lessening the effects of malinvestment into the housing sector.

And the BOC has generally been more stable in terms of its overnight rate:

Nowadays, however, there are genuine concerns about the Canadian economy "headed off a cliff." Given that the US exported more than 260 billion dollars worth of goods to Canada last year, that's not great news for the USA, either.

Fed Leaves Interest Rates Unchanged, Markets Head Down

The Fed announced today that, as expected, it will not change the target Federal Funds Rate. This follow's last month's rate change when the Fed increased its target rate from 0-0.25 up to 0.25-0.50, which was the first increase in seven years.

Today's lack of action thus leaves the target rate near what are historic lows:

Given that the markets expected no change, there was little reason to expect any big movements in the markets, but according to observers in the financial media, the Fed's statement is being interpreted as pessimistic, which drove down markets further. 

We've known for years that the Fed has been ill-at-ease with the overall state of the economy, of course. If the Fed had thought the economy was doing well, it would have raised rates long ago. December's rate hike came in many ways as an attempt to send the message that, yes, the economy is strong enough to warrant a rate hike. 

But the Fed knows that even with a 0.25 percent hike, it's pressing its luck given the extensive reliance of the current global economy on easy money. 

Indeed, even when markets began to suspect that the Fed might raise rates, the Dow Jones headed down. As early as August, when it seemed that the Fed might raise rates at its September meeting, the DJIA began to fall. The Fed chickened out in September, but eventually followed through in December. The market subsequently had one of its worst New-Year openings in decades:

Where does the Fed go from here? It seems plausible that any additional rate cut would be seen as a sign that the economy is weakening. Which could itself cause deflation. On the other hand, an additional rate hike would cause deflation as well, for other reasons.

Bank of Japan Goes Negative, "Strong Dollar" Surges

In a surprise move, the Bank of Japan announced last night that it would employ negative interest rate policy for the first time in its history.

The formula for this is rather complex. It's based on interest for bank reserves held with the central bank, and it seems that only new deposits will be charged the negative rate.
We're not talking about a straightforward single rate on overnight lending, as is the case for say, the federal funds rate in the US, or the overnight rate in Canada.

Naturally, the dollar has surged compared to the yen, and the dollar continues to look like a safe haven by comparison. But only by comparison, of course, since central banks, partly due to collaboration, and partly due to internal politics, are engaged in a race to the bottom.

Japan has long been leading the race to the bottom, however, since its overnight rate (the Mutan rate) has been under one percent since about 1996:

It's been pretty close to zero most of the time since 1999. (Since I can't find a good source for historical targets, this graph is not of target rates. Its of observed rates, which nevertheless reflect the target rates.)

The observed rate over the past five years has been around 0.06% to 0.09%.  (Not to be confused with 0.6% to 0.9%).

The target rate has been at 0.1% since 2009, and thus less than half of the US target rate (0.25) during that time. The sheer length of time that the rate has remained near zero is what's especially notable, however. (Graph from this source.)

Following the gospel that 2% price inflation will solve one's economic problems, the BOJ has been desperate to get price inflation up above zero, where it has usually been for the past decade, except for a surge in late 2014 and early 2015 as Abenomics intensified

The Japanese economy has continued to weaken, and apparently things have been bad enough to cause the BOJ to follow in the footsteps of the European Central Bank, and do "whatever it takes."