NEAM Insights

There’s a popular adage on Wall Street: “Don’t Fight the Fed.” Investors have followed that advice religiously since 2009, when the Fed initiated the first round of quantitative easing (QE). This injection of liquidity along with a zero interest rate policy has served to support risk assets, driving both bond and equity prices higher for the last several years. By suppressing volatility and fostering an upward bias in financial assets, the Fed, playing the part of the shepherd, has encouraged investors to herd like sheep. Read More

The Fed Then… As 2015 marches on, we draw closer to the first rate hike by the U.S. Central bank in nearly a decade. This time, however, the rate hikes that will eventually occur have a decidedly different flavor than those from previous cycles. From the 1970s through the mid 2000s, the Federal Reserve was fighting a different war. As price levels moved higher during the 1970s and early 80s, the Fed’s role was largely that of inflation fighter. Even throughout the late 1980s and 90s, long after inflationary pressures had leveled off, the Fed sought to err on the side of caution in an effort to maintain price stability by staying “ahead of the curve.” It was not always successful in this regard, but one thing remained clear – the Fed was keenly aware of building price pressures. It fought many battles and ultimately won the war (see Chart 1). Read More

A Bit of Theory Most commentators previously believed that interest rates were subject to a zero lower bound (ZLB) and thus it was inconceivable that nominal interest rates could be negative. The idea of a negative interest rate, however, is not new. Keynes cited the idea proposed by the German economist Silvio Gesell in the late 19th century to impose a tax on holding money and many economists have written about it since then, from Irving Fisher in the thirties to, more recently Willem Buiter – a former member of the Bank of England’s Monetary Policy Committee. In 2009, Greg Mankiw referred to negative policy rates as a policy option in the New York Times. Read More

The fragility of the European banking sector was exposed during the euro area sovereign crisis of 2010–2012. Policymakers now hope the opposite is true of banks–improved liquidity, capital strength and supervision leading to greater confidence, higher lending volumes and a recovery in euro area economic growth. In this Quick Takes we review how the banking sector has rehabilitated itself and whether policymakers’ hopes are justified. Our conclusion is a qualified “yes.” Read More

Euro Area interest rates have been hitting new historic lows and yields on many bonds have actually turned negative. Claudio Borio, head of the monetary and economic department at the Bank for International Settlements in Basel, (which acts as an advisory body for central bankers) recently wrote that “bond markets show us day after day [that] the boundaries of the unthinkable are exceptionally elastic” and the idea of a bond having a negative yield was certainly unthinkable until quite recently. Read More

It is important for insurance companies to have well-grounded expectations for the coming year with respect to fixed income investment returns. In an effort to provide guidance to clients and others, we have used GR–NEAM’s proprietary return projection methodology to establish a realistic target for fixed income returns and a reasonable range of outcomes for fixed income portfolios of the U.S. P&C insurance industry for 2015. Read More

The fall in Euro Area (EA) inflation during the last twelve months has been a surprise to policy makers and market participants alike. In addition to current headline inflation reading of slightly above zero—longer term inflation expectations have also declined. A lackluster growth/deflationary outcome would represent a significant medium term challenge to some EA sovereigns that still require de-leveraging and structural reform. Read More

Interest rates will rise. Of that we are relatively certain. However, we are less certain regarding the start date, sequencing, severity and the sustainably of the increase. Insurers are accustomed to managing the uncertainty of insurance risks. How should they manage investment risk in an uncertain rising interest rate environment? Read More

Regulatory Development In November of 2012, the Treasury Market Practices Group (“TMPG”), an industry group sponsored by the New York Fed, announced “best practices” guidance for forward-settling agency mortgage backed securities (MBS). In keeping with the growing regulatory concern surrounding systemic risk, TMPG now recommends that parties post collateral, or margin, to mitigate counterparty risk owing to market value changes. The new regulation applies to the primary dealers (the twenty one trading counterparties of the New York Fed) and, by extension, to entities that trade with the primary dealers. The new guidance will apply to all trades with a contractual settlement greater than one business day (three business days for CMOs), with implementation targeted for January 1, 2014. Read More