There’re plenty of people who think negative interest rates are a good policy. But we don’t really think so at the Federal Reserve. And I think it’s an area of real uncertainty in the central banking world.
-Fed Chair Jerome Powell, 60 Minutes interview, 5/13/20
The Federal Reserve (Fed) has unleashed a wide range of policy moves to support the economy and keep financial markets running smoothly in the face of COVID-19 related economic weakness. In a series of speeches last week, culminating in Fed Chair Jerome Powell’s appearance on 60 Minutes on Sunday evening, May 19 (recorded on May 13), Fed policymakers have definitively signaled their reluctance to use negative rates as a policy option.
“The Fed certainly has the ability to push rates into negative territory if it wants to,” said LPL Financial Chief Investment Officer Burt White. “But the results have been mixed, and even if it helps borrowers, it can hurt lenders, and even more importantly, savers.”
As shown in the LPL Chart of the Day, there is over $11 trillion in negative-yielding debt right now. Negative yielding debt creates a topsy-turvy world in which lenders, who usually charge borrowers interest, actually pay borrowers interest instead. This can work if, for example, a certain amount of lending is structurally required, or fees associated with loans provide some added compensation, or lenders anticipate the value of a loan will increase, as bondholders might if they thought rates could fall further.
While negative rates certainly create an added incentive to borrow, potentially increasing economic activity, as a policy move its impact has been marginal. While borrowers are more willing to take out loans, lenders, primarily banks, are less inclined to create loans and find profitability more challenging when they do.
The Fed instead has found other ways to make it easier for banks to lend, by loosening some policy constraints and making regulatory changes. Through its various lending facilities, the Fed has also helped create additional lending itself where it is most needed.
It is possible the Fed will have to turn to negative rates at some point. But for now, they are showing that they have a wide range of other policy options at their disposal that can potentially have a more meaningful impact. We are cautious about government overstep into free markets and would be eager to see the Fed step back down the road as assertively as it has stepped up. But until then, we believe the Fed’s decision to avoid negative rates is appropriate, not just because it’s avoiding a tepid policy move, but because it’s pushing them to find better alternatives.
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