Are interest rates headed back to zero lower bound?

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Federal Reserve officials steadfastly proclaim their patience on rate changes and many, most notably Board Chair Jerome Powell, have said they see no reason to change rates up or down. But the market is pricing in at least one rate cut this year and many economists expect a downturn in the next year or two.

During the Great Recession, interest rates hit zero lower bound, which caused the Fed to make unprecedented moves, or quantitative easing, to spur the economy.

Will the U.S. reach a point where zero lower bound again constrains monetary policy? In an Economic Letter, Jens H.E. Christensen, a research advisor in the Economic Research Department of the Federal Reserve bank of San Francisco, writes, “there currently appears to be a low risk … for at least the next several years.”

Christensen cited three economic models, all of which “suggest that there is a relatively small chance of the U.S. economy going back to the ZLB within the next couple of years, and this risk is likely to remain low in the foreseeable future.”

Not everyone agrees with this assessment.

The suggestion that the rate won't be back to ZLB in the next few years was called “laughable” by Kirk Kinder, owner & financial planner at Picket Fence Financial. “The stock market is actually pricing in cuts as evidenced by the rapid appreciation since the Fed's capitulation in December. If we see any move in the stock market of 10% or more (negative), we will probably see either a rate cut or a reversal of its balance sheet reduction (or both). The stock market now knows it controls the Fed. If it wants more stimulus, it throws a 10% or 15% hissy fit. Since 2008, that has pushed the Fed to accommodate with stimulus.”

While not expecting rate cut this year, Andrew M. Aran, partner at Regency Wealth Management, said, “We disagree that there is little chance of the Fed returning rates to zero for at least several years as they are, in our opinion likely to adopt a ‘Draghi’ type approach if the U.S. economy and the investment markets encounter surprising pressures to the downside.”

Indicators, he said, while softer than last year, have been “on balance constructive.”

Economists generally expect a bond market crisis to trigger the next recession, according to John Dunham, managing partner at John Dunham and Associates, so “it would seem that investors would demand higher interest rates to lend funds — even for relatively safe assets like Treasuries. This would suggest that market rates would not fall but rather (as they did last time) rise into the recession.”

And if the Fed cuts rates to ZLB, “there would be no real benefit to the economy,” he added.

Economic news
The Conference Board's Leading Economic Index rose 0.2% in April, after a 0.3% gain the month before, while the coincident index gained 0.1% after a similar rise in March.

The lagging index dipped 0.1% after a 0.2% increase in March. Economists polled by IFR Markets expected the 0.2% rise in the headline number.

Consumer sentiment hit a 15-year high of 102.4 in the University of Michigan’s preliminary May survey, well above the 97.5 predicted by economists. The expectations index was at 96.0, its highest level since 2004, after an 87.4 reading last month, and the current conditions index inched up to 112.4 from 112.3 in April.

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