Could Negative Interest Rates in the US Ever Happen?

Art by Aart-Jan Venema

Terrible. Yuck. Who wants that garbage?

Negative interest rates, touted by some as a cure for torpid economies, have had mixed results in Europe and Japan, and get lambasted by much of the US financial establishment. But prominent American supporters, like President Donald Trump, keep pushing them.

What would it take for negative interest rates to come to US shores? An even deeper financial mess than now, with deflation eroding economic activity and no other remedy working. “I wouldn’t rule them out,” commented Randy Hare, director of equity research at Huntington Private Bank, adding that the Federal Reserve would first turn to other strategies.

To Robin Diamonte, CIO at Raytheon Technologies, it’s unclear whether negative rates outside the US have met their goals. Nonetheless, she said, “I have learned that you ‘never say never.’ If the US economy went into an extended deflationary period, the Fed could be forced to re-look at all the tools in the toolbox.”

Amid deflation, businesses and consumers don’t spend, preferring to wait for prices to go still lower—a toxic situation for economic growth. That was the baleful climate in the Great Depression. Indeed, in early 2015, Europe saw deflation of 0.6%. Around that time, the European Central Bank (ECB) imposed negative rates as an antidote.

With negative rates, a central bank charges lenders a fee to store their reserves. The maneuver is meant to push them to channel the money instead into making loans and thus spur the economy. Sometimes, consumer deposits are hit with interest charges, rather than receiving interest payments from the banks. This is intended to entice people to spend rather than to hoard cash. For borrowers, rates get a lot lower. Those double-digit charges on your credit cards? They would plummet. So go out and spend, spend, spend.

In the eurozone, thanks to the ECB, deposits get deducted 0.5% in negative interest annually (although European banks exempt a lot of consumer accounts in a bid to attract the deposits the banks need to do business). Typically, depositors don’t pay the interest out of pocket. The sum is subtracted from their accounts. In Japan, the rate is less hefty, amounting to minus 0.1%.

If official negative interest rates ever show up in the US, investors and savers today are getting a taste of what they feel like. Because interest levels are so low, due to the coronavirus-induced recession, a number of US rates are in effect negative when you factor in inflation. Meaning people are losing money on some interest-bearing vehicles, whose rates are only positive in nominal terms.

The Consumer Price Index for the 12 months ending July 31 was 1%. Hence, for a 10-year Treasury note, yielding 0.65%, a bondholder is losing 0.35% annually. For a one-year certificate of deposit (CD), the average rate is 0.31%, Bankrate says. Thus, a CD holder loses 0.69%. Treasury inflation-protected securities, or TIPS, now have a real (inflation-adjusted) yield of minus 1.1%. You want deflation along with that? In the spring, the price of oil actually turned negative as demand dried up, reaching minus $38 per barrel.

After the global financial crisis, with gross domestic products (GDP) in the doldrums, central banks of several major economic powers went the negative route. Worldwide, there now is $13 trillion in negative interest rate debt. In addition to the ECB, adopters are the Bank of Japan, the Swiss National Bank, Denmark’s Danmarks Nationalbank, and Riksbank Bank of Sweden. Disappointed at the results, Sweden (the first to go negative, in 2009) backed out last year.

Trump, with an eye on re-election and looking for ways to juice GDP even before the pandemic zapped it, has long pressed the Federal Reserve to lower rates and even make them negative. “As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the ‘GIFT’. Big numbers!” Trump tweeted in May. Last fall, he characterized the Fed as “boneheads” for disdaining negative rates.

In a recent paper. Harvard economist Kenneth Rogoff argued that negative rates were the perfect nostrum to turn around the ailing US economy, which the Fed expects to shrink by 6.5% this year.

He contended that sub-zero rates could hike demand, boost employment, and save businesses from default. “It is not rocket science,” Rogoff wrote. “With large-scale cash hoarding taken off the table, the issue of pass-through of negative rates to bank depositors—the most sensible concern—would be eliminated.”

Negative Outlook on Negative Rates

While the traditional take on negative rates is to dismiss them as unworkable, at least in the US, the subject keeps cropping up. And not just as a hypothetical. At one point in the spring, Fed Funds futures, which give a window into what the benchmark rate might do in the future, showed negative numbers next year and the following. A dozen contracts maturing from April 2021 through March 2022 were priced to show a rate of between minus 0.01% and minus 0.025% at contract expiration.

Fed Chair Jerome Powell has made a point of saying the central bank was not looking at heading into negative territory. That echoes a longstanding stance by the Fed, whose policymaking committee in October termed the negative concept ”not attractive.”

Powell said the Fed preferred alternatives such as forward guidance—that is, policymakers signal to the debt markets how long current rates will stay in place—and massive asset purchases, also known as quantitative easing, or QE. “We’ve said that we continue to rely on those tools that are tried, and they are now a part of our toolkit,” he said.

The strongest case against negative rates in America revolves around the special status of the US dollar, which is the globe’s reserve currency and is used in the vast bulk of financial activity internationally. “Our money markets are a major financial intermediary,” said Jim Keegan, CIO and chairman of Seix Investment Advisors. The fear is that trade and money transfers would get messed up. Plus, he said, with negative rates, the US’s insurers and pension funds, which invest for the long-term, would have a tough time figuring out future values of their assets.

Not helping the argument for negative rates in the US is their mixed, at best, record in Japan and Europe. Bank lending margins there have been crimped by negative rates in recent years, and the lenders have turned more to wealth management and investment banking for their profitability.

The negative policy “hasn’t spurred corporate loans” overseas, said Cameron Brandt, EPFR’s research director. In Japan, which is less of a consumer economy than the US, he said negative rates have induced people to “spend less and save more,” which isn’t the recipe for dynamic economic growth.

What’s the Trigger for Below-Zero Rates?

If the economy is really circling the drain and all the Fed’s vaunted rescue tools prove ineffective, then and only then would the Fed turn to negative rates, according to various financial experts. That would mean that QE, forward guidance, and the various Fed-created lending facilities are impotent.

Such an eventuality appears unlikely, but so did home mortgages almost destroying the world’s financial system, or a disease decimating humanity and its economy. Negative rates seem like a real outlier, yet they’re hard to dismiss as a last resort.

“I don’t see that coming,” said Marnie Owen, global head of technical analysis at Informa Global Markets, of a turn to rates with minus signs. “Negative interest rates are at the bottom” of the range of choices that the Fed would consider, she said. Regardless, she added, the central bank could turn to them if some dire circumstances arose.

Owen has some whimsically named scenarios for what might prompt the Fed and the rest of the financial establishment to accept negative rates. One she calls “the Big Oops,” where the market imposes less-then-zero rates, perhaps misreading some Fed action.

Another, “Till Debt Do Us Part,” envisions Washington’s debt load becoming so onerous that Treasury auctions fail. That’s not very far-fetched: Two weeks ago, as part of the fundraising to fuel the massive government borrowing lately, a $26 billion auction of 30-year paper met with weak demand. So-called primary dealers, who are required to buy leftover supply, ended up swallowing 28.3% of the paper, up from 21.4% in May.

With still another scenario, “Plunging into Darkness,” the credit markets seize up as they did in March, except this time the Fed is out of gas to make things right. That no doubt would bring forth a howling wilderness you’ve seen in many apocalyptic movies.

Well, what’s reassuring is that no such civilization-ending episodes are very likely. Right? Um …. Right?

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