The stress test scenarios aren’t a forecast, per se, but they mean the Fed at least sees those conditions as possible. The whole exercise is pointless if the scenarios could never happen. I think this stress test scenario is the clearest sign yet that the Fed views NIRP as a legitimate alternative.
It doesn’t mean NIRP is guaranteed. I believe Yellen when she says their policy is “data-dependent.” They are no more prescient about the future than the rest of us are. All they can do is look at the data and try to respond appropriately. I don’t envy them that job.
I think the Fed is right now in a position much like the one that was portrayed in that 2010 staff memo. They see their last big move as not having had the desired effect and are considering a new set of options. NIRP is on their list.
Having decided to put NIRP on the list, the Fed has to make sure the banking system can handle it. Whether it can is far from clear right now. The technology issues alone could unleash chaos if the Fed went negative without warning. I think putting negative rates in the stress test scenarios is the Fed’s not-so-subtle message to Wall Street: “Get ready; this could really happen.”
If Europe’s experience means anything, it seems likely our banks aren’t ready yet. Consider this Mar. 4, 2015, Wall Street Journal story.
Widespread negative interest rates, once only a theoretical possibility, have become a real-life problem for Europe’s financial system.
From Sweden to Spain, banks, brokers and other financial firms are grappling with technical and legal glitches thrown up by negative rates, forcing them to redesign computer systems, tear up spreadsheets and redraft legal contracts.
The issue echoes the scrambles around the Year 2000 computer bug and the launch of the euro, when some bank systems couldn’t handle the introduction of a new currency, said Kevin Burrowes, head of U.K. financial services at PricewaterhouseCoopers. A handful of malfunctioning computer programs can cause “huge problems,” while working around problems manually makes more controls necessary and increases the risk that something could go wrong, Mr. Burrowes said.
Preparing for NIRP is a far smaller challenge than preparing for Y2K, which required years of reprogramming and hundreds of billions of dollars, but it is still a huge project. Some reports say European banks are still dealing with the programming issues. And technology is only part of the problem. Think of all the contracts and other legal documents that might need rewriting and renegotiation. If nothing else, the Fed just stimulated the securities and contract law businesses.
One small example from my personal experience: I have been involved in the management of several large commodity funds over the past 25 years. Back in the day, commodity funds had a significant advantage in that they could put 90% of their money into short-term government bonds to generate the capital for their futures contracts. This interest offset a lot of their fees in the ’80s and ’90s. Not so much today. I suspect that many of the organizational documents required still state that such funds will use short-term Treasuries as their cash base.