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Could the Federal Reserve adopt negative interest rates?

News Team, 30/03/2020

Negative interest rates could be utilised by the Federal Reserve to prevent a global recession becoming a global depression, according to Andrew Seaman from Stratton Street Capital.

Negative interest rates are hardly a new concept for developed economies and global banks, and are normally considered last- resort measures adopted by economies in turmoil. Sweden’s Riksbank was the first central bank in the world to implement a negative interest rate in 2009 following the previous financial crisis. The measure is often associated with Japan’s lost decade in the 1990s, which followed the asset price bubble collapse and resulted in years of economic stagnation. Consequently, is unlikely to be the first port of call for America’s financial institutions.

Mr Seaman outlined that although the firm’s base case was that the Federal Reserve would adopt a combination of zero policy rates and quantitative easing, the unique nature of an event-driven recession meant all options had to be left on the table.

In particular, he cited the challenging macroeconomic conditions, which he believed made the current situation almost unprecedented. Last week, the US Labor department reported that 3.28 million jobless claims had been filed to the department, a 281,000 increase on the following week. 

These are figures which dwarf numbers seen in all previous recessions in the US. In addition, he cited St Louis Federal president James Bullard, who predicts that the unemployment rate could hit 30 percent in the second quarter, alongside a 50 percent decline in GDP.

This contrasts markedly with the former previous record lows in 1932, when US GDP contracted by 12.9 percent in real terms, and in 1946 when the economy contracted by 11.6 percent.

He also pointed to credit spreads, which remain at uninspiring levels. In his view, this indicates a lack of willingness by market participants to lend to even strong investment grade credits. Consequently, he believes federal reserve may be forced to do more “heavy lifting”.

Forecasting a scenario where the Federal Reserve could utilise negative interest rates effectively, he argued they could set five or 10 year yields at a negative yield and purchase unlimited amounts of treasuries at the new negative rate.

This would, in his view, achieve several things at once. It would boost the price of treasury bonds and improve the balance sheets of those with risk-free assets on their books. Secondly, it would allow holders of treasuries (and mortgage bonds) an easy exit in order to obtain desired liquidity.

He also felt that the displacement of market participants would force them into corporate credits, causing spreads to tighten. Provided spreads narrow sufficiently, firms requiring longer term funding will be able to do so using traditional market mechanisms.

Commenting on who would benefit from such measures, he said: “The major beneficiaries of such a policy would be the highest rated investment grade credits, particularly quasisovereigns. Some high yield credit may also benefit from this. However, until confidence is fully restored, highly leveraged companies faced with a collapse in demand may not be able to fund themselves at any price, regardless of the policies implemented by governments and central banks.”

It should be noted that the possibility of negative interest rates remains unlikely in the US.  Mr Seaman acknowledges that as recently as 15th March this year, Federal Reserve chairman Jerome Powell dismissed the likelihood of using negative interest rates to stimulate the U.S. economy.

Mr Powell said: “We do not see negative policy rates as likely to be an appropriate policy response here in the United States.”

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