Analysts see many types of bullets for Fed use, other than negative rates
Federal Reserve officials, most notably Chair Jerome Powell, say they still have ammunition to spark the economy. While the Fed hasn't really defined what tools they will use, one thing is certain — negative rates are a last resort.
So what can the Fed do? More of what they've been doing, according to Steven Oh, global head of credit and fixed income, PineBridge Investments. “That ammunition is more along the lines of expansion and extension of current programs. Clearly, the Fed has used its ammunition as it relates to traditional policy rates and its aversion to enact negative rates,” he said. “But among the most effective tools is the signal of support as much as the actions themselves, as evidenced by the impact of the corporate bond-buying program prior to actual commencement of purchases.”
Perhaps, it's not just a single tool. Steve Skancke, chief economic advisor at Keel Point and former White House staffer, noted, “Each of the policy tools has its own targets, so there is synergy in them being applied together.”
And the Fed is aware of this. “With what has been done so far, it would seem that the current Fed priorities are synced with perceptions of what is most effective: Purchase of Treasury and asset-backed securities, quantitative easing, credit facilities for commercial, state and local borrowers and dollar swaps with other central banks.”
The Fed has been creative, noted Yohay Elam, senior financial analyst, fxstreet.com, and could look for niches where the government won't offer assistance. “The most effective tools would be filling in for where the government is shy to enter, such as state and municipal bonds,” Elam said. “That would reduce financing costs as authorities struggle with soaring pandemic-related bills. Expanding classic quantitative easing — buying long-term government debt would be the second most effective tool.”
He agrees the Fed should avoid negative rates, a policy that failed in the eurozone and in Japan.
But some don't believe the Fed will be able to avoid it. "Negative policy interest rates are an inevitability in my view, although probably not in the immediate future,” said Greg McBride, chief financial analyst, Bankrate.com. "Just as the Fed was cutting interest rates in 2019 as other global central banks raced to the bottom, the same phenomenon will eventually bring on negative interest rates — and a host of unintended consequences, starting with the $4 trillion money market.” said Greg McBride, chief financial analyst, Bankrate.com.
Not that he sees that as a positive. "Negative rates have not proven to be effective and are arguably nothing more than an experiment," he said. "Central banks in Europe have been using negative rates for seven years. How has that worked out? Their economies were reeling then, and they're reeling now."
But, the Fed has an out: it can "print money," according to Roger Hewins, founder and president of Team Hewins. “I think there is a serious commitment to avoid negative rates, and those will not be necessary anyway,” Hewins said. “The Fed can ‘print money’ and buy assets, including fallen angel fixed income. That will be their most potent weapon.”
Direct intervention in financial markets will get the most bang for the buck, according to Bill Zox, portfolio manager of high yield and corporate credit for Diamond Hill Capital Management. But “this also distorts markets the most and does the most damage to the Fed’s credibility.”
“So far the Fed has had a dramatic impact on the credit markets while committing only a small fraction of the capital under its control,” he said. “It seems like the Fed has plenty of ammunition" without negative rates.
Ron Carson, CEO and founder of Carson Group, is a proponent of forward guidance. “The Fed would be expected to raise rates down the line only after they end some of the crisis facilities (like they did with QE tapering before getting to raising rates in the last decade),” Carson said. “Letting the market know that the credit facilities would continue for an extended period of time would indirectly provide guidance on interest rate policy.”
Support for companies that have curtailed business and access to capital are essential so expansion of its lending facilities would be the strongest tool, said Ian Seaver, investment director-fixed income at Hartford Funds. “Given that the evidence around the effectiveness of negative rates is mixed and that rates would potentially need to be cut meaningfully into negative territory to have the desired impact, this tool is likely further down the list,” Seaver said. “Central banks in countries that have been operating with negative rates have been reluctant to cut further, potentially highlighting the diminishing impact.”
Jamie Sullivan, CFO of tru Independence, noted the Fed has already utilized some of its most effective and efficient ammunition. “The next order of business will be ensuring that businesses and local governments are able to access the benefits of the lending and bond buying programs, now it’s time to act on the promised initiatives,” she said. “The lending and credit expansion programs are probably the least effective, as there tends to be many fiscal and administrative hurdles to obtain the funds.”
With the Fed committed to low rates until the crisis is over, Gary Zimmerman, CEO of MaxMyInterest, worries about inflation when the economy re-opens and consumers are unleashed. “When economic activity resumes, there could be inflationary pressures, so the Fed may need to be prepared to raise rates on short notice,” he said.