(The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own.)
By Mike Dolan
LONDON, May 12 (Reuters) - The risk that the coronavirus shock will seed a nasty bout of deflation in the debt-laden U.S. economy means markets are rational to consider at least some chance that Federal Reserve policy rates could head below zero.
In the last week, futures markets briefly priced in a first move into negative territory for Fed policy rates by mid-2021, a path already trodden by the European Central Bank, Bank of Japan and Swedish Riksbank in the decade since the financial crash.
On Tuesday, April statistics showed the headline annual rate of U.S. consumer price inflation falling to as little as 0.3% — its lowest since 2016 and a whisker away from the Fed’s 0-0.25% target range for overnight interest rates.
While core inflation excluding volatile energy prices was a healthier 1.4%, that fall in inflation could mean ‘real’ interest rates are not deeply negative enough to swiftly revive the virus-hit economy as the Fed hopes.
And the speed with which Fed officials have queued up in recent days to dismiss negative policy rates seems at odds with a whatever-it-takes stance that has embraced most other “out of the box” ideas in tackling this sudden stop in the economy.
Their main concern appears to be the potential damage that negative rates do to the banking system, which the Fed relies on to kick-start lending and act as a conduit for its monetary operations.
That’s certainly been the growing worry in the euro zone since the ECB went sub-zero in 2014. Banks as well as savers have lobbied against the policy in Germany and elsewhere — successfully enough that the ECB did not cut its main policy rate any further in response to the pandemic.
Others fear negative rates risk exaggerating a “paradox of thrift” where savers earning less and less in interest just end up saving even more.
But some economists are convinced the Fed has taken negative rates off the table too early. They say the policy should be part of its toolkit of extraordinary measures to help avert a depression and ease the mountain of debt the U.S. government, cities and firms have incurred because of the coronavirus.
Harvard professor and former International Monetary Fund chief economist Ken Rogoff said the Fed needs to consider the chance there is no rapid economic recovery from the COVID-19 shock and that 2019 output levels take many years to recapture.
Writing for the website Project Syndicate this week, Rogoff reckons that in that negative scenario, debts would be unsustainable and creditors would have to be forced to take at least some of the hit in a gigantic workout — leading to an “unholy mess”, years of litigation and a bonanza for lawyers. “Before carrying out debt-restructuring surgery on everything, wouldn’t it better to try a dose of normal monetary stimulus?” he wrote.
Negative rates of -3% or lower could lift firms, states and cities from default, boost demand and jobs and be a boon to many hobbled emerging economies too, Rogoff said. While emergency implementation of deeply negative interest rates would not solve all today’s problems, he added, “if ... equilibrium real interest rates are set to be lower than ever over the next few years, it is time for central banks and governments to give the idea a long, hard and urgent look”.
Rogoff claims objections to negative rates are “either “fuzzy-headed or easily addressed” and he and other economists have suggested measures to deter cash-hoarding to avoid the effective tax.
These range from time-varying fees for cash deposits at the central bank to the withdrawal of large-denomination banknotes and accelerating moves to central bank digital currencies, which potentially allow cash-holding fees to be levied remotely.
As debate about negative rates bubbles again, other previously sceptical central bankers seem more reluctant to rule the policy out.
“This is a question that’s been thought about on and off since the financial crisis, and it’s a balanced judgment,” Bank of England Deputy Governor Ben Broadbent said on Tuesday, adding it’s “quite possible that more monetary easing will be needed”.
But do markets think the Fed is bluffing in its persistent objection to negative rates or just stalling for time?
Mike Kelly, head of multi-asset investments at the $100 billion Pinebridge Investments, said it made sense that futures price in at least the possibility, though he doubted the Fed would go there just yet.
“They will do everything to resist negative nominal rates,” said Kelly, even if a substantial economic relapse meant “everything is back on the table”.
Instead, he reckoned the Fed would rely on real rates of -1% or more in the bond markets to achieve its aims — forcing investors to “de-governmentbond-ize” portfolios.
“What do I do when the U.S. yield curve joins the other two (in Japan and the euro zone) in being lobotomized by policy?”
By Mike Dolan, Twitter: @reutersMikeD. Graphics by Vidya Ranganathan and Stephen Culp, Editing by Catherine Evans