Thursday, September 13, 2012

CFOs tell Bernanke don't bother with zero interest rates or more quantitative easing

An overwhelming majority of CFOs in a Duke University survey say that even with a meaningful reduction in already low interest rates they would not change their spending plans.

Regular readers know that your humble blogger has been saying since zero interest rate policies and quantitative easing were adopted that they would have limited to no impact on business spending.

There are two reasons for this.

First, when businesses make the case for spending more money the first thing they look at is the incremental revenue that the spending will generate.  CFOs aren't seeing any increase in revenue on the horizon.

Second, interest rates factor into a firm's investment decision as one component of the discount rate applied to the cash flows the investment is suppose to generate.  When interest rates get below 5%, the marginal impact of a further decline is insignificant.

According to a Fox Business article,
According to a report released this week by Duke University, the overwhelming majority of chief financial officers surveyed said a meaningful reduction in already ridiculously low interest rates -- the primary goal behind more QE -- wouldn’t cause their capital spending plans to budge. 
“The survey paints a stark picture. In current circumstances, lower interest rates will not spur investment. The potential QE3 is doomed,” said Cam Harvey, a finance professor at Duke. 
The poll comes just before the conclusion of a highly-anticipated Fed summit that market participants believe will lead the central bank to pump more easy-money juice into the financial system. 
But there is a near consensus, including from inside the Fed, that a third bond-buying program or a different form of easing won’t be as effective at stimulating the economy as the prior two iterations. 
Duke’s Global Business Outlook survey goes a step further, showing that further QE won’t move the needle almost at all in terms of capital spending. That is a crucial finding considering the Fed said U.S. nonfinancial corporations held a whopping $1.74 trillion in cash or liquid assets on their balance sheets as of the end of the first quarter.
“Rates have been pushed so low by such highly accommodative Fed policy that we’ve reached a point where sectors of the economy that usually respond to low rates are no longer sensitive,” said David Jones, president of DMJ Advisors and a former Fed economist.

The report showed that 91% of the 1,500 CFOs polled wouldn’t bolster their spending plans even if the Fed’s programs successfully lowered interest rates by one percentage point. And 84% said a hefty two-point reduction in rates wouldn’t change their spending plans either. 
“Rates are already at historic lows, so lower rates would not impact our decision,” one survey respondent said. 
Another CFO said, “We need to see reliable growth before we are willing to invest any further.” 
As noted above, the business investment analysis starts with looking for additional revenue.  If there is no additional revenue, there are no cash flows to be discounted using the Fed's artificially lowered discount rate.
At the same time, higher rates wouldn’t seem to alter the capital spending picture much, either. 
Just 14% of respondents said a one percentage point increase in interest rates would cause them to delay or cancel their investments. 
This is a very important observation.  It says that the Fed could abandon the zero interest rate policies with minimal impact on business investment.

By abandoning zero interest rates and raising interest rates, the Fed could start to restore a return for savers.  The result of increasing the return on savings would be more consumption by savers.

This would trigger a positive feedback loop where greater demand leads to greater business investment and job growth ...
“CFOs are saying that simply focusing on interest rates is misguided. In this environment of 50-year interest rate lows, a lower rate makes no measurable difference,” Harvey said.
Please re-read the highlighted text again as this is the point about the true lower bound for interest rates that your humble blogger has been making.  Quite simply, interest rates are already in a range where further lowering rates make no measurable difference.

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