Will Fed need to consider negative rates without stimulus?
The Federal Reserve has vowed to do whatever it takes to keep the economy going, but ruled out negative interest rates except as a last resort.
What is the goal of negative rates? What has been learned from their use in other countries? With passage of a stimulus plan unlikely before the elections, will the Fed need to reconsider?
“The goal in this nontraditional measure is to get people to spend money,” said Megan Horneman, director of portfolio strategy at Verdence Capital Advisors. “This may be effective, but it does not solve the issue that Americans need money. Combined with fiscal stimulus it may be more effective.”
But, experience shows “negative rates have failed to lift inflation expectations,” according to Brian Rehling, Wells Fargo Investment Institute head of global fixed income strategy. “While inflation can largely be fought with higher interest rates, disinflation has proven to be a more complex enemy to combat.”
Should the Fed fail to raise inflation or expectations, he said, consumers could hold off on spending to see if prices drop, “further entrenching the enemy that is disinflation.”
And while negative rates seem like a natural answer — lowering rates even into negative territory should cause inflation — “the expected increases in growth and inflation have failed to materialize,” Rehling said.
Another lesson learned from those using negative rates is the importance of having “significant fiscal stimulus” to get the maximum benefit, he said. “Whether a coordinated approach can ultimately allow the economy to generate a more permanent positive growth rate remains unclear,” Rehling said, “but it has a better chance of success than monetary policy alone.”
Investors shouldn’t fear negative rates, since they “can lift financial asset prices,” he added. “Negative rates do not necessarily mean negative returns.”
The Fed meeting its dual mandate is “paramount,” according to Kevin Philip, managing director at Bel Air Investment Advisors. "The first and foremost thing one must remember is that the Fed will do whatever it needs to in order to support employment, prevent deflation, and encourage modest inflation.”
Despite the many statements by Fed officials against using negative rates, they will use negative rates, if needed, he said.
“While politically unfavorable and potentially challenging for a system as large and complex as the U.S., other central banks have now demonstrated the capability of negative interest rates to have some effect on a stressed economy, albeit the degree of which is still debated,” Philip continued. “Given the impasse in Congress for additional fiscal stimulus, we are probably one market dislocation away from the Fed rolling out the next batch of tools; and there isn’t much left but more quantitative easing, the expansion of types of assets the Fed purchases, and negative interest rates."
But, Steven Oh, global head of credit and fixed income for PineBridge Investments, doesn’t see the Fed adopting negative rates. “We are quite far away from circumstances that would result in the Fed seriously considering negative rates,” he said.
And while the Fed wants to remain flexible and has “not explicitly dismissed negative interest rates,” they have clearly stated concern about the policy “as the resulting negative impact is likely to outweigh any benefits.”
Separately, durable goods orders grew 0.4% in August after an upwardly revised 11.7% rise in July, the Commerce Department said.
The July number was originally reported as an 11.4% increase.
Economists polled by IFR Markets expected a 1.5% gain.
Excluding transportation, orders rose 0.4% after a 3.2% increase in July. Economists expected a 1.3% rise.
Core capital goods orders, which is considered a sign of business investment, gained 1.8% in August after a 2.5% climb in July.