What Would Negative Interest Rates Mean For Commodities
Negative interest rates are becoming more popular around the world as central banks seek to stimulate economies by inhibiting saving and encouraging spending and borrowing. When a central bank lowers short-term interest rates to a level where they become negative, banks charge depositors storage on their deposits which is counter-intuitive to most savers who expect a yield for their deposits. However, in Japan and parts of Europe economic conditions have become such that monetary authorities have gone negative on interest rates in an attempt to jump start economies.
In the United States, short-term interest rates fell to 0% in the wake of the global financial crisis in 2008. They only began to rise once again in December 2015 when the Federal Reserve hiked the short-term Fed Funds rate for the first time in nine years. While the U.S. economy was experiencing moderate growth in 2015 and early 2016, contagion from other economies around the world, including Europe, Japan, and China continue to threaten U.S. economic growth and further interest rate hikes.
The U.S. economy is the world’s largest. As such, the U.S. currency, the dollar, is the reserve currency of the world. A reserve currency is a paper currency that has the backing of the full faith and credit of the government that prints it. In the case of the dollar, other central banks around the world hold dollars as reserve assets because of the currency’s stability. The dollar has a unique role in the world.
It is the pricing mechanism for most raw materials or commodities. While dollar interest rates fell to zero over recent years, they never went negative. Negative dollar interest rates would likely have a significant impact on commodity prices.
The historical inverse relationship between the dollar and commodity prices is likely to cause commodities to rally in response to negative dollar rates.
If the U.S. central bank found itself in a position that required negative rates to stimulate the economy the value of the dollar would likely drop. A lower dollar would be a bullish influence on raw material prices. Additionally, it would cost less to finance commodity inventories if interest rates were to go negative. The value of a dollar in the future would be worth less than a dollar in the present. Therefore, borrowing dollars and then buying and storing actual hard assets like commodities would result in a positive cash flow for the borrower of the currency. In the case of negative interest rates, a borrower could use the proceeds of a loan to purchase physical gold, silver, copper, crude oil or any other commodity. Negative interest rates would likely entice consumers to build inventories for the future as financing would be a benefit rather than a cost.
Central banks have many tools at their disposal when it comes to managing economies. In many cases, these governmental bodies coordinate policies and actions with one and other. The mission of monetary authorities around the world is to create an economic environment that is stable while encouraging growth for their individual nations.
A coordinated policy amongst nations is meant to encourage overall, global macro growth.
Changes in interest rate policy and intervention in global currency markets go hand in hand for central banks during periods when they believe economic conditions warrant such moves. Commodities are hard assets while currencies and interest rates are paper assets. When it comes to commodities, most central banks around the world hold gold as part of their foreign exchange reserves. The United States is the world’s leading governmental gold holder while European governments also hold significant gold bullion in their portfolio. Until recently, China and Russia held less gold as part of their reserves than the U.S and European nations. However, over recent years, the Russians and Chinese have been increasing their holdings as a percentage of total reserves.
Governments also hold other important commodities as part of their reserves. The United States holds significant oil inventories in salt caves located along the Gulf Coast of the nation. China and Europe also hold strategic petroleum reserves. Commodities are important assets for any nation's overall portfolio. The production of these hard assets is local, in countries and regions of the world where the geography and climate allow for production. However, consumption is widespread – all people around the earth are consumers of raw materials either directly or indirectly. Therefore, governments must make sure that sufficient supplies required for their citizenry are available to meet demand.
Rising commodity prices can cause inflationary pressures on an economy. Negative interest rates are inherently bullish for commodity prices. Negative yields on currencies could have a long-term inflationary effect; therefore, central banks are likely to use this type of monetary tool only as a last option in managing economies around the world.