Fed Would Be Foolish to Take Rates Below Zero

(Bloomberg Opinion) -- It’s occasionally surreal to write about Federal Reserve policy alongside former Fed officials..Narayana Kocherlakota, president of the Minneapolis Fed until 2015 and a fellow Bloomberg Opinion columnist, has been out in front of the Fed’s actions from the onset of this crisis. In a Feb. 24 column, he urged the Fed to immediately lower interest rates rather than wait until its March 18 decision, even though current central bankers like Fed Vice Chair Richard Clarida were still claiming it was “too soon” to know whether the coronavirus outbreak would materially change the economic outlook. Eight days later, the Fed delivered a dose of shock and awe with its first emergency rate cut since 2008. Then on the Sunday before its scheduled March meeting, the Fed dialed its benchmark rate all the way back to near-zero..Kocherlakota gave central bankers yet another splashy piece of advice last Friday, writing that the Fed should cut interest rates to at least 25 basis points below zero at its meeting this week. “The Fed is left no good argument against going negative. Terrifyingly high unemployment and potentially rapid disinflation are powerful arguments in favor,” he wrote..I disagree. There are many reasons Fed officials are rightfully reluctant to take the unprecedented step of bringing negative policy rates onto America’s shores..Most obviously, the Fed has telegraphed what it would do at the zero lower bound before succumbing to negative rates: yield-curve control. Fed Governor Lael Brainard in November laid out precisely the situation the central bank finds itself in today and said traders might expect the central bank to start capping yields on short-to-intermediate Treasury securities by intervening with asset purchases to set rate levels it deems appropriate. What’s more, the New York Fed not so subtly published a blog post on April 6 titled “How the Fed Managed the Treasury Yield Curve in the 1940s.”.“We think the Fed's next likely easing steps may be yield curve control and enhanced forward guidance,” Bank of America Corp. strategists wrote in a report on Friday. TD Securities has a similar view: “We also look for officials to explicitly adopt average inflation targeting and to announce some form of yield curve control by year-end.”.Of course, the Fed is arguably already doing just that with its huge purchases of U.S. Treasuries. The central bank’s balance sheet has ballooned to $6.57 trillion, up more than $2 trillion in just six weeks. With such a heavy hand in the market, the 10-year Treasury yield has moved in a range of less than 25 basis points over the past month. To put that in perspective, it swung by at least that much during every single trading session from March 6 to March 20..I’ve called yield-curve control a nightmare for bond traders. But opening the Pandora’s box of negative interest rates would be even more agonizing because it would have far-reaching consequences for the banking system and could even damage the psyche of an already fragile American public..Far from being at the epicenter of this economic crisis, the largest U.S. banks have held up their end of the bargain as the country grapples with an unprecedented lockdown. Companies and individuals poured a record $1 trillion of deposits into U.S. banks in the first quarter, with more than half going to Bank of America, Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. The Wall Street Journal quipped: “Call it a reverse run on the bank.” Meanwhile, money-market fund assets have swelled to $4.65 trillion, far and away exceeding the previous peak from January 2009. .That’s all happening even though deposits and money-market funds yield next to nothing. What would happen if people actually lost money seeking a safe place to sock away their cash? .Yes, in theory, a small penalty encourages individuals to spend rather than save, boosting the economy. The search for positive returns spurs greater risk-taking and suppresses borrowing costs for companies so they can innovate and hire more people. It sounds perfectly plausible. Indeed, Kocherlakota stated that “negative interest rates would help lower the unemployment rate from what is likely to be its highest level since World War II.”.Actual evidence from Europe and Japan is far less cut-and-dried. Sure, unemployment has fallen in Germany and so-called peripheral countries like Italy and Spain since the European Central Bank first cut its deposit rate below zero in 2014. But it’s hard to know how much of that was the result of the ECB’s action versus just riding the global economic expansion. What’s plain to see is that sub-zero interest rates have done little to sustainably boost price growth. Core inflation in the euro zone has never topped 1.5% in the last five years. In Japan, it’s never climbed above 1%..This suggests that negative interest rates might just be disinflationary. It’s not hard to extrapolate why: If individuals are saving and have a negative return in their money-market funds, there are two choices. The first is take more risk, the other is to just sock away even more cash for the future. America already faces something of a retirement crisis — now, in the midst of coming out from under a global pandemic, investors should be asked to roll the dice in their 401(k)s or see their cash balance slowly erode? In the words of Bloomberg News’s Michael McKee, who often asks questions of Fed Chair Jerome Powell at Fed press conferences, “that will stoke resentment, not demand.”.As usual, Fed policy makers will never quite say never. “We do not see negative policy rates as likely to be an appropriate policy response here in the United States,” Powell said at his March 15 press conference. That implies that some set of circumstances could change their minds. .The current situation doesn’t rise to that level. The jobless claims numbers have been staggering, but another quarter-point cut to interest rates isn’t going to fill up restaurants, movie theaters, hotels, cruise ships and airplanes. If anything, the Fed’s various emergency credit facilities have come closer to achieving that goal by helping to provide market access to companies in need of cash like AMC Entertainment Holdings Inc., Carnival Corp., Hyatt Hotels Corp. and Marriott International Inc. Delta Air Lines Inc. is set to borrow $3 billion on Tuesday..The Fed should focus squarely on getting these programs up and running rather than heading down a potentially dangerous and entirely unnecessary path. Interest rates are not the central bank’s only tool anymore. Leave them be..This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners..Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder..©2020 Bloomberg L.P.

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Fed Would Be Foolish to Take Rates Below Zero

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