Negative Interest Rates and the Implications for Money Market Funds

Published: October 15, 2020

The conditions now facing the global economy are unprecedented. For many countries, interest rates have been close to record lows since the aftermath of the 2008 global financial crisis. While some central banks had already taken the plunge into negative territory, the coronavirus pandemic and its economic implications have led others to consider the idea.

Here we examine what may happen to interest rates in the UK, Europe and North America.

In the UK

We don’t believe the Bank of England (BoE) will choose to go down the negative interest rate path with official rates. Even after a number of years of negative interest rates in Europe and Japan, the effectiveness of such a policy is still under debate. And with the banking sector having a larger contribution to the overall UK economy than in many other countries, anything that lowers the profitability of that sector could dampen banks’ appetite to lend.

However, it’s worth pointing out that our thinking may be at odds with general opinion. Although the BoE’s Monetary Policy Committee (MPC) hasn’t formally lowered the boundaries of interest cuts into negative territory, it did support the idea that the economy and balance sheets would be boosted by negative rates. The Governor of the BoE Andrew Bailey has also said that negative rates are in the toolbox, although there are no current plans to use them.

However, issuance rates in money markets are another matter, with some of our counterparties already issuing at negative rates. We’ve seen and forecast stress points, particularly around quarter ends and MPC meeting dates. Will this lead to net negative or negative rates driven by expectations or supply driven?

In Europe

The European Central Bank (ECB) cut interest rates to zero in 2013, but that wasn’t enough to get growth going again after the financial crisis. So in June 2014 the ECB went negative, to a cautious -0.10%, creeping down gradually to the current level of -0.50%.

The ECB’s rationale for its negative interest rate policy has been that strong banks benefit from a lower cost of funding, which can then be passed on to borrowers. In turn, this stimulates the economy in much the same way as traditional rate cuts. It’s widely accepted that negative rates have become the new ‘norm’ in Europe, and aren’t simply a temporary measure to stimulate the economy.

During the current crisis, the ECB hasn’t deviated from its approach. However, it is aware that negative interest rates could squash demand in the economy rather than giving it a boost. This is one of the reasons rates have moved incrementally lower – testing the waters. The ECB is now clearly waiting for additional information about the speed and strength of the recovery from the coronavirus crisis, and how much extra fiscal help it will receive from European authorities. But we expect the ECB to keep rates as they are for the foreseeable future.

In the US

During the height of the coronavirus crisis, markets began to price in the possibility of a negative US rate policy as the Federal Reserve and government used the monetary and fiscal levers available to them to try to lessen the impact and restore some calm. Although Fed Chair Jerome Powell has stated that further action can and will be taken as necessary to combat the effects of the pandemic, he pushed back on actually implementing a negative rate by explicitly saying “for now it’s not something we are considering” during questioning in May.

This and more in-depth discussion seen in the Federal Open Market Committee minutes from October 2019 cited the evidence from implementation of a negative rate policy in other regions as “mixed”.

The discussion also concluded that the role and size of the US’s financial system, the likely knock-on effects to household and business spending plans, and the distortion of incentives for financial intermediaries to lend were all reasons that made negative interest rates unsuitable. Another important point mentioned was that the US’s large money market industry, which has $5.1tr. of assets, isn’t currently equipped to deliver negative returns. However, it didn’t go so far as to rule out the possibility entirely.

To read more about our views on negative rates, please download our thought piece on the topic.