The Descent

Lou Brien |

Negative rates!! Of course negative rates, the answer to the questions about inflation and growth. It seems so obvious now; Dolan, you’re a genius.

Oh sure for years there was a taboo about negative rates; look, but don’t touch. Not that anyone was ever very anxious to venture down that path; too much of an unknown; the logistics were not clear, and the legality was not assured. For all intents and purpose there was also an invisible force field known as the “zero lower bound”; can’t penetrate that. Back in November 2002 when Bernanke spoke about making sure deflation doesn’t happen here he explained that negative rates was not a tool the Fed could utilize, “When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target,” said the future Fed Chair in that famous speech. Curses Zero Bound; drat you!

Besides the Fed didn’t need to go underground with rates because Quantitative Easing meant they could go stimulate above and beyond the low but positive interest rate anyway; why be negative, right?

Yeah, central banks have tinkered with negative policy rates in recent years, but mostly that was by adorable little countries like Switzerland, Sweden or Denmark. OK, the ECB is not cute or diminutive, and they took its Deposit Facility Rate to less than zero back in June 2014 and even lower since then, down to negative 0.30% now. Yet it didn’t seem to reverberate back to US shores; it was a euro zone thing, a situation peculiar to the single currency. Maybe I missed it but I don’t recall any insinuation of the ECB negative rate policy over to the Fed.

But that is not the story today; a snap of the fingers and suddenly negative rates seems like a shiny new monetary policy tool. Wasn’t always there, but now, there it is! Like someone photo-shopped them into the team picture; “Heh; who’s that guy next to Forward Guidance?” Not exactly sure how negative rates work, but a little tinkering in the workshop could make it viable, should the situation present itself. Yellen told the Senate Banking Committee that the Fed was reviewing negative rates; “I wouldn’t take those off the table, but we would have work to do to judge whether they would be workable here.” Negative rates may never happen here, it may all be an academic exercise, but there they are, a possible option for the future, right in the team picture.

Let’s be clear the Fed is not planning on going sub-zero. They plan on hiking rates not making them disappear. Sure the path higher is probably going to be shallower than the FOMC first hinted at; financial market volatility, don’t you know. Yellen told Congress last week the Committee expects that economic activity will expand, the labor market will continue to strengthen and eventually inflation will rise to the Fed’s target. Given this backdrop the Fed will need to make gradual increases in the funds rate, explained the Fed boss. There is no preset course for monetary policy, Yellen reiterated and, as always, she reminded that it is better for the Fed to stay a step ahead rather than risk falling behind and have to play catch up and therefore need to tighten abruptly. So even though there is more uncertainty now, the song remains the same; the Fed figures they are embarking on a rate hike cycle not preparing for negative policy rates.

Regardless, I don’t remember a time when the idea of the Fed taking a policy rate below zero was trending so much as it is now. It would be easy to blame the Bank of Japan; they went negative with a key rate on January 29; first time ever for them. It is quite a concession seeing as how they have been battling sluggish growth and deflationary tendencies for a quarter century and just now they landed on the idea that the way out of their dilemma is to take policy rates into negative territory. And by the way, they are prepared to go further below zero if need be, warned BoJ Governor Kuroda, in a clear suggestion that the more stubborn the problem the more negative the rate that was necessary to combat it. As far as I know it is not a long held opinion of Japan’s top banker; he was said to have been against the idea when he showed up at Davos in the middle of January.

Interestingly, on the day the Japanese acted the Fed released a paper that was written almost six year ago, it is dated August 5, 2010; “Reducing the IOER Rate: An Analysis of Options”. It is a study of the impact of reducing the interest on excess reserves; three cases were examined: “cutting the IOER rate to a level of about 10 basis points, reducing the rate to zero, and setting a negative IOER rate.” The paper investigated the implications of such policy rates on things such as money market funds, holding currency in banks, and even legal constraints of such a strategy.

The point is not the details of that paper, or the subsequent thread of connected Fed papers and SEC rulings that seem to untie the trip wires of having a negative policy rate that were uncovered by the August 2010 paper. My quandary is that all of a sudden the use of negative policy rates seems to be considered such a clever idea.

In the two days of Humphrey/Hawkins testimony Chair Yellen was asked, two, three or maybe even four times, about the idea of negative rates, often citing the relatively obscure paper I mentioned above. Why?

There is a wide range of views concerning the efficacy of negative rates; running the gamut from delightful to disastrous.

Discuss amongst yourselves.

But it seems to me that now that the subject has been broached it is a good time to get a grip on what it means.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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