Getting negative on negative rates

admin | December 6, 2019

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As the Fed lowered rates this summer, the conversation inevitably turned to the possibility that policy could drop to zero or beyond. Mario Draghi and the ECB eventually cut rates further into negative territory in hopes of jumpstarting the European economy.  But lately most Fed officials have rejected the prospect of negative rates in the U.S., and many policymakers in Europe have complained about the unhealthy ramifications of persistent negative rates there. The appetite for negativity has diminished.

FOMC comes out against negative rates in the U.S.

With fed funds in the neighborhood of 2% and falling this summer, the discussion turned to what might happen if the Fed returned to the zero bound, and some suggested that the FOMC should consider taking rates into negative territory, emulating what most central banks in Europe (and others) have tried.

A few Fed officials may have stoked that conversation by noting, when asked, that negative rates would be a possible option the next time the Fed faced the zero bound.  Often, these types of statements come in response to an audience or press question at a public appearance, but newswire headlines do not often provide adequate context.  Market participants most often assume when they see a headline communicating that a Fed official discussed the prospect of negative rates that he or she broached the subject of their own behest rather than in response to a question.

The October FOMC meeting should put any thoughts of negative rates in the U.S. any time soon to bed.  The most evident reason is that the FOMC declared that it was moving into pause mode, suggesting that the easing campaign of 2019 is over.  The Fed could, of course, lower rates further at some point if the outlook dictated it, but the near-term prospect of a return to the zero bound has receded considerably.

However, the October FOMC minutes revealed last month revealed a more decisive statement.  The Fed Board staff briefed the committee on the range of monetary policy tools available to the Fed at the zero bound as part of the ongoing monetary policy review.  While the committee was favorably inclined toward asset purchases and forward guidance, the main two options used after the Financial Crisis, there was far less enthusiasm for negative rates.  In fact, the minutes stated:

“All participants judged that negative interest rates currently did not appear to be an attractive monetary policy tool in the United States.  Participants commented that there was limited scope to bring the policy rate into negative territory, that the evidence on the beneficial effects of negative interest rates abroad was mixed, and that it was unclear what effects negative rates might have on the willingness of financial intermediaries to lend and on the spending plans of households and businesses.  Participants noted that negative interest rates would entail risks of introducing significant complexity or distortions to the financial system.”

Officials also noted that negative interest rates were likely to have more adverse effects in the U.S. than in other countries given the structure of the financial system here.  It is rare these days for the FOMC to unanimously agree to anything, so the passage on negative rates can fairly be viewed as an unusually emphatic rejection.

Discontent in Europe

On his way out as President of the ECB, Mario Draghi pushed through an aggressive round of easing in September that included a cut further into negative territory for the deposit rate (from -0.40% to -0.50%) as well as a renewal of asset purchases.  At the time, Draghi’s dovish aggression was applauded by market participants, though there was considerable dissension within the ECB itself.  In fact, public statements suggest that a considerable minority of central bankers on the ECB opposed parts of or the entire package.

Draghi’s replacement, Christine LaGarde, is also viewed as dovish, though she has little background in monetary policy.  Her career focus has been more on fiscal policy, and, not surprisingly, she has taken up a frequent mantra of Draghi’s – that European governments need to enact structural reforms to help boost growth in the region, taking some of the pressure off of the ECB to support the economy.

What is interesting is that in recent days, fiscal authorities and banks have been pushing back in a new way.  German banks have recently taken the long-delayed step of beginning to pass along negative deposit rates to their retail clients, a step that will bring the downside of negative rates homes to German households (i.e. voters) in a very real way.  German politicians have responded by complaining loudly to the ECB and by considering legislation to protect retail depositors from negative rates.  A recent Bloomberg article indicates that the chorus of ECB opposition to negative rates is growing, including from some, such as the Bank of Italy Governor, who had been consistently dovish in the past.  European market economists have taken note of these cues and have abandoned once-consensus calls for an additional rate cut by the ECB before the end of the year.  More importantly, the conversation has turned to whether negative rates cause more harm than good, a far cry from the prevailing view just a few months ago.

Conclusion

There was a point in time earlier this year when there seemed to be a fair amount of momentum in the running financial market narrative of the global economy and monetary policy toward the attractiveness of negative rates.  That trend has shifted pretty sharply over the past few months, and as 2019 ends, the Fed has emphatically rejected the option while the ECB seems to be souring on its own policy setting, which is pretty deep into negative territory although there is no plausible route for the ECB to get out of its negative rate policy any time soon, even if the committee were so inclined.