Will the Fed Follow the ECB?

Last week, the European Central Bank cut its benchmark interest rate to a record low of -0.5 percent. That’s right, MINUS! Big commercial banks now have to pay the ECB a little bit more for the privilege of keeping money in reserve. The move is intended to encourage those institutions to lend money, which would theoretically spur economic activity. And if negative interest rates are not enough of an incentive, the central bank also announced new bond purchases (remember QE?).

The ECB is not alone as central banks in Japan, Switzerland, Denmark and Sweden also sport a minus sign. Negative yields first appeared in 2015 and currently there is about $17 trillion worth of global sovereign debt yielding less than zero. So far, those negative rates have not produced a growth spurt. The ECB said that the economic outlook is still dim: forecasts are for 1.1 percent growth this year and just a bit more in 2020, due to the global manufacturing slowdown, the effects of trade conflicts, and the persistent uncertainty over Brexit.

There are a few reasons why someone might lend money to a government for ten years, only to be contractually obligated to see less than the total amount returned:

(1) With global growth mired at low levels, some investors believe that many of these central banks will continue to stimulate economies with monetary actions, like bond buying, which will push up prices.

(2) Some might purchase negative yielding debt because they need a safe, liquid investment. It is in fact cheaper to lose a bit of money on a government bond than to park vast sums in a vault and then pay a guard to watch over the stash.

(3) Others might accept a negative interest rate for speculative reasons, hoping to unload a high priced bond with a negative yield to someone more desperate for safety.

Amid the low/negative yield world, the Fed is set to begin a two-day policy meeting this week, prompting some to wonder whether the Fed will follow the ECB? There’s a way’s to go before the funds rate goes negative, but the central bank is likely to cut by another 0.25 percent, to between 1.75 percent and 2.00 percent.

And despite the President’s needling tweets (“The Federal Reserve should get our interest rates down to ZERO, or less”), there is some doubt as to whether the central banks could implement negative rates in the U.S. without causing problems for short-term funding markets, which would hurt businesses, banks and markets.

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