A recent analysis from Pimco portfolio manager Jerome M. Schneider highlights the potential risk of the United States entering a negative interest rate environment.
Schneider points out that the risk is materializing due to the expiration of unlimited Federal Deposit Insurance Corporation (FDIC) insurance on demand deposits, which is set to expire on Dec. 31.
He notes that when the European Central Bank (ECB) recently cut its deposit rate on excess reserves to 0%, it led to this scenario. "Symptoms include euro money market funds halting inflows and in some cases liquidating completely, repurchase agreements and T-bills trading at negative yields, and European banks turning away clients' interest in CDs at any level," Schneider wrote, adding, "For European cash investors, the prospect of negative yields, or effectively, paying for safekeeping of your monies, is a very real consequence of the ECB decision."
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While Schneider calls the chance of the Federal Reserve following the ECB's lead as remote, he adds that the possibility must be considered. He says the expiration of the unlimited FDIC insurance takes $1.4 trillion in 100% insured deposits and turns them into uninsured obligations of the bank. "Come January, what was once a virtually 'risk free' asset for investors will instantaneously become risky."
This could lead to turbulence in the short-term markets.
Daniel Petree, managing director of enhanced cash management firm Cornerstone Investment Management, agrees with Pimco's analysis and believes the expiration also provides firms like them an opportunity. "It has been easy not to do anything," Petree says of the environment with the FDIC guarantee, which was put in place to prevent runs on the banks. Now that it is expiring, absent any last minute congressional extensions, a lot of money could be exiting these banks.
"We don't have credit risk, we think we are a good alternative for some of this cash," Petree says.
Schneider says Pimco believes that a majority of the $550 billion in insured deposits seen since 2010 will leave this safe harbor. "At such time, liquidity investors will be forced to allocate between taking the additional credit risk, or remaining as an unsecured creditor [and] accept the cost of near 0% yields."
He adds that given the size of money that will be transferred, first movers will have an advantage.
For more on this topic, see Depositors Fleeing Euro Get Negative Rates, Clients Trying to Avoid Deposit Charges and What Would Negative Rates Really Mean?
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