Here are 5 reasons why the Fed probably won't do the 'unthinkable'
Mohamed El-Erian
President @ Queens' College, Cambridge | Finance, Economics Expert
Not so long ago, negative nominal interest rates were thought unlikely if not unthinkable. Zero was deemed the floor or “lower bound,” that is the level below which nominal interest rates could not fall. Indeed, few if any economics textbooks deemed negative rates enough of a “tail risk” to warrant some discussion, no matter how brief.
Today, a handful of central banks in Europe and Japan have taken their policy rates into negative territory. Almost a third of the debt securities issued by governments around the world now trades at negative yields, meaning that buyers pay rather than get rewarded for holding the bonds.
The amounts involved are big. According to Fitch’s calculations, investor “payments” on the $10 trillion of negative yielding bonds now amount to $24 billion on an annual basis
Few people expect this situation to change any time soon. They are right.
They are also correct in noting that the longer negative rates persist in Europe and Japan, the greater the downward pressures on rates in other parts of the advanced world.
Some market observers have even gone further in projecting that the US Federal Reserve will end up by also implementing NIRP (that is, a negative interest rate policy). Here are 5 reasons why this third prediction is unlikely however.
The US economy is a lot stronger than Europe and Japan
While far from brilliant and frustratingly running below its potential, the US economy is notably stronger than those of Europe and Japan. As such, the Fed is more likely to raise interest rates in the next few months than it is to reduce them. Moreover, since the relative strength of the domestic economy is not just cyclical but also structural, US economic outperformance is likely to persist for a while assuming no major policy mistakes.
Little evidence suggests negative rates are effective
There is little evidence to suggest that negative rates are effective in promoting economic activity. There are even some emerging signs from Japan, albeit quite partial at present, that they could make consumers more risk averse, thereby acting as a headwind to growth. Japan is in the forefront of this risk of counter-productive outcomes.
Negative rates are unpopular
Japan's Emperor Akihito (3rd L), flanked by other members of the royal family, waves to well-wishers who gathered to celebrate his 82nd birthday in Tokyo, Japan.
Negative rates are not just attention-grapping, but also unpopular among segments of the population. As such, and as illustrated by the recent German and Japanese experiences, they place a very bright spotlight on central banks. In turn, this exposes these politically-shy institutions to greater scrutiny by politicians who don’t understand enough about monetary policy. Consequently, central banks face the risk of mounting threats to their much-cherished operational autonomy.
Pressure increases on a central bank the longer negative rates persist
Federal Reserve Board Chair Janet Yellen testifies before a Senate Banking, Housing and Urban Affairs Committee hearing on the "Semiannual Monetary Policy Report to Congress" in Capitol Hill, Washington
The longer negative nominal rates persist, the greater the pressure on the established institutional setup that provides financial services to the population at large. This is particularly the case for suppliers of long-term financial contracts, protection and safeguards (such as pension funds and life insurance companies).
The Fed is more likely to do QE again
If push comes to shove in the United States – and assuming that the central bank is forced to continue as “the only game in town” policy wise in the midst of a growth collapse – the Fed is more likely to revive its “QE” program (its large-scale purchases of government debt) than take its interest rate negative.
Mohamed A. El-Erian is is the Chief Economic Advisor for Allianz, the parent company of PIMCO where he was CEO and co-CIO (2007-2014), and Chair of the President’s Global Development Council. His latest book – “The Only Game in Town: Central Banks, Instability and Avoiding the Next Crisis” – is a New York Times Bestseller.
Consultant
8 年Maybe FED is doing the next hike kidding the planet :-)
Capital Markets and Investment Professional
8 年We've already had QEIII. The next one will be QEIV. Look the Fed is the only entity that is pulling out all the stops trying to get the U.S. Economy going, and by extension, the rest of the world. Monetary Policy in, and of, itself can not save the worldwide Economy. It needs a partner, that partner is Fiscal Reform. To date Fiscal Reform has not been forthcoming. The Fed isn't "lying", they are trying to strike a balance. They don't want the Bond Vigilantes to think they are soft on Inflation, even though it isn't a concern in the least. So they talk 'Hawkish' to the world in order to keep Rates, especially long Rates, low. They also are realistic, they know we have an exceptionally weak Economy that can't take Rates much beyond where they are now, hence their 'Dovish' tone. If you look at any measure of the 'Cost of Capital' for the last thirty five years, from the Funds Rates to the 30yr Bond, you will see a constant and deliberate decline. Rates have been falling for thirty five years, so this current Rate Policy is simply a continuation of Policy we've had in affect for thirty five years, the current FOMC just ran out of room. It was inevitable we would get to zero and perhaps move to negative. But I don't think the Fed will go to NIRP though. They must realize, risk/reward, it won't pay off. We've had ZIRP for seven, or, eight years now. The cumulative effects of ZIRP on savers and Pensions will be felt for decades to come. NIRP would literally kill Pensions. If they must do something, they should set the Funds Rate at 1.0% and roll all the short Duration Securities they have, say 7yr's and in, into 10yr and greater. If they need to do something more they should buy outright 10yr and 30yr paper.
President, Licensed Registered Investment Advisor
8 年QE3?
Principal at TitaniumCRE
8 年Evan, because the fed is lying. They lied that QE promoted a recovery and now they're pretending they can raise rates. Just watch what they do, not what they say. The fed will never raise interest rates again, ever. It's mathematically impossible without collapsing multiple markets.