Central Bankers Do the Limbo

Vito J. Racanelli

It seems these days central banks are doing the interest rate Limbo dance.

The Limbo dance requires participants to pass under a low bar without falling over or dislodging the bar. Every round, the bar gets a little lower. Sounds a lot like central bankers trying to deftly navigate monetary policy with every round of easing leaving them less room to maneuver.

The ECB just this week lowered its deposit rate to -0.5% from -0.4% (it first "bent" below zero in 2014) and announced new bond purchases. This is going from loose to ultra-loose policy. What comes next if policy loosens further? Even lower rates, or possibly helicopter money.

Europe is troubled by falling wages and an absence of secular growth trends like the ones that have benefited the US (shale revolution, tech sector), which means ultra-loose monetary policy could be a lot of lubricant on a damaged engine.

And in his speech following the ECB meeting, Draghi stressed that Europe's governments must loosen their purse strings. He recognizes that an economy needs effective fiscal as well as monetary policy to function properly.

The Euro has continued to depreciate against the Dollar and fell again following the ECB’s latest cut, which supports their exports but greatly displeases President Trump who tweeted Thursday: "European Central Bank, acting quickly, Cuts Rates 10 Basis Points. They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports…. And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!"

What the President wishes to see is rates at “ZERO, or less”, which the US has so far avoided following 2008. He believes bringing rates down further would allow the US to refinance its debt at lower rates, but the efficacy of this proposal is unclear. And of course, there is the ongoing concern of what tools the Fed will have left if rates are at zero (or less) and a recession hits.

The CME Fed Futures Market, previously predicting a 100% chance of another rate cut at the next FOMC meeting, now shows 80%. Powell is likely feeling pressure to keep up with his central banking peers across the pond in continuing to support markets through monetary easing. He's next to do the Limbo.

The 10-yr note yield ended Friday around 1.90% versus 1.56% the previous week.

Upcoming: 9/17-18 - FOMC meeting.

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Vito J. Racanelli
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