Week End Blog – Zero is NOT the Lower Bound!

Zero is not the lower bound! The graph below shows this was already the case, but this week the ECB and Sweden’s Riksbank hinted at even lower rates going forward. The latter could be pushed by the former as the size of ‘Draghi-style’ QE is too much for Sweden’s central bank to counter with FX intervention. Hence, we could see deposit rates go even lower!

Draghi’s statements on the possibility of more QE still echoed this week, pushing the euro firmly below 1.10 against the US dollar. The euro recovered somewhat but the significant move reveals that any divergence in central bank policy will be reflected in currency exchange rates.

Another fine example of this mechanism was presented by the depreciation of the Swedish Krona against the euro, after the Riksbank stated its dovish stance. The amount of Swedish bond buying already went up, and a further decrease of the repo rate was suggested.

With central banks taking another step down the easing road, interest rates are falling as well. Switzerland, Sweden, but also Germany, and even (briefly) Italy and Spain are all examples that zero is not the lower bound. A significant part of the yield curve ‘pays’ interest rates that are clearly below that threshold.

The graph below shows that things could become even more extreme. Earlier this year the German 10-year government bond reached an all-time low of just 7 basis point. 7! I don’t expect this level to be hit again, but when it comes to central banks you just don’t know anymore. Zero is just not the lower bound.

Let’s move over to a central bank in the East. The Bank of Japan refrained from more stimulus, although more was expected by almost half of the ‘Bloomberg gurus.’ However, during the press conference after the monetary policy decision, Mr. Kuroda emphasized that all options remain open. Mr. Kuroda also added that the he ‘doesn’t see JGB buying becoming difficult.’ So, although the Bank of Japan already owns almost 30% of all outstanding government bonds, ownership can still increase from here.

The Bank of Japan buys both equities and bonds. This week a graph floated on Twitter that shows that Mr. Kuroda now owns more than half of Japan’s ETF market. I should add here, however, that a quick look at market caps reveals that Japan’s ETF market represents a very small percentage (roughly 3%) of the market capitalization of the Nikkei 225 Index.

Next up is the Fed. The Fed demonstrated this week that is has become a bit of an outlier. In a more hawkish statement than many expected, the Fed kept the door to a rate hike in December wide open. The Fed removed a phrase from its statement that expressed worries about the economic situation abroad. It also explicitly mentioned that the possibility of a rate hike will be discussed in December. Still, I don’t think they will do it. The stronger US dollar is already working as tightening, growth is not that great, but also December is a difficult month for implementing such decisions as market liquidity slowly dries up towards the end of the year.

US Q3 GDP growth came in at an annualized pace of 1.5%. This was the slowest Q3 of the last three years, and also below expectations. Economists already suggested growth will pick up from here, something I don’t necessarily disagree with, but I remember that a good starting point for forecasting next quarter’s GDP growth, is last quarter’s GDP growth.

In addition economist have a remarkable track record in overestimating GDP growth, as the chart below reveals. I’m a firm believer in the overoptimism hypothesis, in which investors, economist, and all other people, suffer from severe overoptimism. Something which is, for example, neatly expressed in GDP growth forecasts.

Last, but not least, it has been gone away some time, but bitcoin is back in the Week End Blog. In recent months the price of bitcoin has been rising rapidly. Actually, bitcoin has reached its the highest level of this year. Some say this has all to do with the strengthening easing cycle by central banks. Could be although, last week’s FOMC statement did not halt the bitcoin rally. Others assume that as the bitcoin technology comes of age, the value of bitcoin again increases. I don’t know exactly, but I do know it’s up significantly since August 25.

Thank you for reading the Week End Blog. Enjoy your weekend!




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