Why the U.S. Has Shunned Negative Interest Rates: QuickTake

NEW YORK (Capital Markets in Africa) — Investors have speculated that the U.S. Federal Reserve may push its benchmark overnight interest rate into negative territory to help offset the economic devastation of the coronavirus pandemic. President Donald Trump has said doing so would be a “Gift” to the U.S. economy. Fed officials led by Chairman Jerome Powell have consistently opposed it.

What are markets saying?
Implied yields on futures contracts linked to the federal funds rate have gone below zero in recent days. That suggests bets that the Fed will by mid-2021 cut its key rate below the current range of zero to 0.25%, something it’s never done. Accounting technicalities are also influencing the trading, analysts say.

What would negative rates mean?
The theory goes that by introducing sub-zero rates, investors would shift to purchasing other short-term or riskier assets and the rates on those assets would fall, making borrowing cheaper across a range of securities and providing a spur to the economy.

What do Fed officials say?
Powell has repeatedly pushed back against the idea of negative rates. During the last recession, which ended in 2009, Fed officials considered a variety of tools and chose not to deploy them, Powell has pointed out in the past. “We do not see negative policy rates as likely to be an appropriate policy response here in the U.S.,” he told reporters on March 15. In more recent comments, Fed colleagues have agreed without completely ruling out the option. On May 11, Federal Reserve Bank of Chicago President Charles Evans said: “At best, we’d have to study it more, but I don’t anticipate that being a tool we would be using in the U.S.” On the same day, Atlanta Fed President Raphael Bostic said: “I am not a big fan of going into the negative rate territory.”

Why the objection?
For the most part, it’s unclear how much of an economic gain negative rates would deliver, and there are worries they could roil financial markets. In a 2010 memo, Fed staffers raised concerns about the impact on banks and money market funds. Some economists argue that there’s a limit on how far rates can be pushed down before they perversely start to hurt the economy. Banks could face pinched profits and also need to pay to hold deposits at the Fed rather than collect interest, which could make them even less likely to provide credit. The risk in money markets relates to concerns that investors could start boycotting them and seek yield elsewhere. The U.S. relies on these markets — at a size of roughly $4.8 trillion — more than economies elsewhere. In minutes of an October Fed meeting, officials say the risk of “significant complexity or distortions to the financial system.” Moreover, it’s a policy that would arguably target the wrong end of the yield curve, as longer-term rates are the benchmark for mortgage borrowing and corporate credit.

What do U.S. lawmakers say?
While Trump has repeatedly called on the Fed to consider negative rates, other lawmakers may think otherwise. There are even suggestions it could be illegal. In 2008, the Fed gained explicit authority from Congress to pay commercial banks interest on reserve balances deposited at the central bank. It’s not clear whether that authority extends to establishing negative rates on those reserves. When the Fed first reduced rates to a range of zero to 0.25% in 2008 and kept them there for seven years, it was frequently criticized by lawmakers for short-changing savers.

What other countries have used negative rates?
The European Central Bank became the first major institution to push short-term interest rates below zero in 2014, as it tried to combat a lingering economic slump. The Bank of Japan followed at the start of 2016, and by the middle of that year some 500 million people in a quarter of the world’s economies ended up living with rates in the red. Since central banks provide a benchmark for all borrowing costs, negative rates spread to a range of fixed-income securities. Central bankers have recently shown a reluctance to push benchmark rates deeper into negative territory and banks have criticized the policy. Sweden’s Riksbank became the first major central bank to end its policy of zero rates in December.

What else can the Fed do to spark demand?
Fed officials have already slashed rates and pledged to buy a sweeping amount of assets. But they have other tools — such as larger-scale bond purchases and committing to stronger interest-rate guidance to try to combat the recession. Yield-curve control — whereby the Fed targets a specific level of yield on government bonds at one or more maturities — may be another efficient way to tether borrowing costs that are most relevant to growth. The Fed studied the possibility of lowering rates below zero in the 2008-2009 financial crisis and its aftermath and found it “wanting,” Vice Chairman Richard Clarida said in March 2019.

Source: Bloomberg Business News