Update 381 — Laissez-Faire to Less-is-More:
Trump Has a Modern Monetary Theory 4 U
Jerome Powell’s bad dream may not last longer than Friday the 13th. But President Trump’s belief that Fed monetary policy should aim for zero interest rates — or we’ll repeal ‘em! — might persist right through the election thirteen full moons away.
Below we consider the implications of negative interest rates from a policy perspective, as well as a political one: who has an interest in negative interest, pro and con?
Good weekends all.
Last week, former Fed Chair Alan Greenspan said in a CNBC interview that it is “only a matter of time” before the U.S. joins many other advanced economies with interest rates in negative territory. With the federal funds rate now sitting at 2.25 percent, the Fed can’t go down 500 bp, as in the past in seeking to head off a recession, without going negative.
This week, President Trump tweeted his dissatisfaction with the Federal Reserve’s pace of rate cuts, proclaiming that, “The Federal Reserve should get our interest rates down to ZERO, or less… the USA should always be paying the lowest rate.”
Once thought inconceivable, negative interest rates have been implemented in developed economies such as Japan and the Eurozone over the last decade. Greenspan’s comments come when the bond market is flashing red (think inverted yield curve) with the 10-year Treasury note currently yielding just 1.89 percent, down by 40 percent from a year ago.
Are we entering an economic twilight zone? And is this reset of our understanding of the capabilities and function of monetary policy? We look at this uncharted territory for the U.S. from multiple perspectives here.
Good or Bad for Banks?
Negative interest rates are an unconventional monetary policy tool used by central banks in Europe and Japan consistently since 2014 and 2016 as they try to stimulate bank lending — and consequently economic growth — in macroeconomic environments blighted by stagnation.
The president of the European Central Bank (ECB) announced yesterday that the interest rate on Eurozone deposits would be lowered from -0.4 percent to -0.5 percent. In a negative interest rate environment, banks effectively pay to hold their excess reserves with the central bank, where normally banks receive interest on their overnight deposits.
This situation has been punishing for European banks as they struggle to find ways to pass on this burden to their myriad clients. This week, J.P. Morgan’s CEO Jamie Dimon said that the bank is preparing for the potential of negative rates. Although he was doubtful that U.S. rates would go below zero, he said that the bank would look into cutting costs and increasing charges on their clients to make up for the cost of negative rates on the bank’s margins.
Dimon’s comments are cautionary regarding negative rates. The supposed purpose of negative interest rates is to encourage banks to lend rather than to keep their money at the Fed. The risk is that banks, instead of increasing lending, pass the costs on to retail consumers in the form of new and/or increased fees.
Should the U.S. Have the Lowest?
Countries with negative interest rates are starting to experience the strange effects they can have on the economy.
- Negative yielding government debt. As central banks in Europe and Japan have taken their interest rates sub-zero, the yields on their government bonds have done the same. The 10-year German bund currently yields -0.45 percent, effectively resulting in investors accepting a negative return by lending money to the German government. Of all German government debt, only the 30-year bund yields a positive return — a measly 0.12 percent. Last month, the total global amount of negative-yielding sovereign debt hit $16 trillion. With the U.S. Treasury market arguably the most prized and liquid in the world, questions remain over how negative rates would affect demand for the ultimate safe haven investment.
- Negative mortgage rates. Last month, it was reported that Jyske Bank, one of Denmark’s largest banks, was offering a 10-year mortgage with an effective rate of negative 0.5 percent. While borrowers will likely still pay slightly more than they take out due to banking fees, it sets a precedent and turns conventional loan finance on its head.
- Negative yielding corporate bonds. A more recent development than negative yielding government debt is negative yielding corporate bonds. The vast majority of this debt is in Europe and recently surpassed the $1 trillion threshold.
Trump Theorem: How Low Can U Go?
President Trump routinely rants about Fed policy and the need for lower interest rates. Lower rates provide stimulus for the Trump economy (mostly to the benefit of the markets), but like the TCJA, it will likely be a short-lived high. Trump’s calls for rate cuts are an effort to save a sugar-high growth spurt that has already frayed at the edges.
Fiscal policy is the principal democratic (and constitutional) method for deciding how the path of economic prosperity should be charted and its fruits shared. If the Fed is boxed into unconventional accommodation tools, it is on risky — and less accountable — policy and political grounds. (Should the Fed toolbox and powers be expanded? If so, Congress would need to weigh in. For another day.)
Just a Mid-Cycle Adjustment
At next week’s FOMC meeting, all eyes will be on Jerome Powell’s rationalization of another seemingly inevitable 25 bp rate cut following from the “insurance” cut at the end of July. Last month, Powell sent markets (and the White House) into a spin over his comments that the change in direction was merely a “mid-cycle adjustment,” not a full-blown change of course.
The Fed has other tools that it can use during a downturn, including forward guidance and its balance sheet. Chair Powell even affirmed that these tools would all be used “aggressively” to help the economy if there was a downturn in the near future. Nevertheless, interest rates remain an important piece of the Fed’s recessionary policy toolkit. As the chatter over negative rates intensifies, let’s see if Powell and the other Federal Open Market Committee members see another rate cut as merely a continuation of just a mid-cycle adjustment, or the start of a potential slippery slope to, and through, zero.