Federal Reserve Chairman Jerome Powell is expected to strongly oppose the idea of negative interest rates when he speaks Wednesday, though President Donald Trump Tuesday said they would be a benefit to the U.S.
Powell is expected to take the opportunity to talk down market speculation about negative interest rates, when he appears in a 9 a.m. ET webcast with the Peterson Institute for International Economics. For the first time ever, the fed funds futures market last Thursday priced in slightly negative rates starting this fall.
Since Friday, a number of Federal Reserve regional bank presidents, like Richmond Fed President Thomas Barkin and Chicago Fed President Charles Evans knocked the idea of negative rates and said the Fed has no plans for them. The futures market has since reversed some of the implied negative rates for the fall and winter, but April, 2021 futures still price the slightly negative rate of minus 0.01%.
“I don’t think it’s a coincidence that Powell is speaking tomorrow. We’ve already had a bunch of Fed speakers, and they say they don’t see there’s much to be gleaned from negative yields,” said Patrick Leary, Incapital chief market strategist.
But for Trump, faced with trillions in new debt, the idea of negative rates is appealing and he said the U.S. should do it as long as other countries are. The president has spoken in favor of negative rates previously, the idea being that investors would pay the Treasury to hold U.S. debt, instead of the other way around.
Since bond prices and interest rates move in the opposite directions, the price of a negative yielding bond would be above par, or its face value. If it moved above that, interest rates would go into negative territory, so in essence an investor would pay the borrower. Negative interest rates were used in Europe and Japan during the financial crisis, and those interest rates are still negative.
“It’s a tax on savers,” said Mark Cabana, head of U.S. short rate strategy at Bank of America. “Americans generally don’t like being taxed on their savings, and I think it would have a very negative connotation to have a saver who has worked hard to make money and wants to try to be prudent by saving it, to then be taxed on that.”
However, strategists said the market could drive real interest rates negative even if the Fed does not target negative yields. The 2-year note yield last week fell to a low 0.09%, a record low, and under the right circumstances, it could go negative just as Treasury bill yields have done in the Great Recession and also during market stress in March and April.
Strategists say there was no news event to drive rates negative in the futures market, but it may have been a technical move. They also said some investors may have been using them to hedge the possibility that the Fed changes its mind if the economy does not improve quickly enough.
Cabana and other strategists said those countries who have negative rates have not seen much benefit from them, and their economies remained sluggish. The fear is there would be financial repression, meaning the government would be able to borrow cheaper but it would be at the expense of other parts of the economy.
Kenneth Rogoff, Harvard University professor, has said the Fed is making a mistake by not having negative rates in its tool kit. He said the Fed’s purchases of corporate debt and junk bonds, which were to start Tuesday, allows even weak companies to stay afloat. He said for now that may not be a problem, but it could become one if there’s another virus outbreak that shuts down the economy.
“I think if we are able to do deeply negative interest rate policy, it would keep a lot of companies afloat. There would be others that would need to be restructured. The fact it’s taken off the table is a mistake,” he said on CNBC.
Powell’s talk Wednesday is said to be about “current economic issues,” but strategists expect him to make a point about the Fed’s often stated opposition to negative interest rates.
“I think it’s possible that he does squash the speculation that they would go there. I don’t want to hear we’re not looking at it right now, or it’s not something we’re thinking we would do. I want to hear a firm: ‘This is not a good. We’re not going to do this,'” said Peter Boockvar, chief investment strategist at Bleakley Advisory Group. “I want to hear an emphatic opinion that this is stupid.”
Leary said the market is pushing the Fed, and it needs a strong response from Powell. “I don’t think the Fed wants negative rates, but the market pricing in negative rates puts the Fed a little bit in a box,” he said. He said if it carries on, the Fed could be pushed if rates go deeper into negative territory. Or on the other hand, the Fed would have to disappoint the market and create a negative reaction.
He said negative rates would hurt the banking sector in particular. “There’s a bunch of systemic problems that would start with negative rates,” Leary said.
Cabana said the Fed has more tools it could use and he hopes Powell speaks about them. One would be a quantitative easing program structured like the programs in the Great Recession, where the Fed targeted assets instead of markets as it’s doing now. The central bank could also use enhanced forward guidance.
He also said the Fed could have raised the interest rate on excess reserves when it last met, and it still can do so. That rate is currently at 0.10%, above the Fed funds rate, which is closer to zero. By moving IOER higher, the fed funds rate could also have moved higher, dampening the market speculation.
“I expect Powell to offer up his assessment of the economic outlook,” said Cabana, noting Powell last said the outlook was uncertain. “I want to know what he thinks now, how worried is he and I hope he says he is very worried, and the Fed will do whatever it can to assist.”