Will Rates in the U.S. Go Negative?
It’s unlikely we’ll follow Europe and Japan, but interest rates will stay low for a while.
President Trump recently suggested that the Federal Reserve lower short-term interest rates to zero or even go negative. When interest rates are negative, commercial banks pay to keep extra reserves in central banks, such as the Fed or the European Central Bank, instead of earning interest. We asked Ed Yardeni, an economist, market strategist and president of investment research firm Yardeni Research, to weigh in about how this affects investors, savers and the economy.
Why is the President calling for negative interest rates? He'd love to refinance the country's outstanding debt at a negative interest rate. That would eliminate the net interest component of the debt, which has been mounting as interest rates have climbed.
We've seen a number of prominent developed countries move to negative interest rates. Why is that? The stage was set by the European Central Bank and the Bank of Japan. They've had negative interest for the past few years, and that has led to big declines in bond yields in Europe and in Japan. Those low yields have spilled over into the rest of the world. More fundamentally, the global economy has been weak. Some of that may be attributable to recent trade wars, but I think there are some other structural forces at play that are keeping a lid on inflation and pushing interest rates lower, such as aging global populations and a mad dash by investors to lock in yields out of fear that interest rates could turn negative.
In environments with very low interest rates, valuations have moved higher. There's a lot of stock market volatility around those basic trends—but we're not that far off from the record highs in the stock market.
Why would any bond investor accept a negative rate? The only rational answer in my mind is if you're expecting deflation. The assumption is, whatever the borrower bought would be cheaper, that the price would go down, whether it be a house or any other asset or durable good. Wherever you're seeing negative bond yields, you're seeing investors pessimistic about the future.
Could we have negative interest rates in the U.S.? There was some discussion of negative interest rates at the Fed in 2010, when its models were saying that the federal funds rate (the rate at which financial institutions lend money to each other) had to be –0.75% to boost economic growth. The Fed decided against it. Even though the European Central Bank and Bank of Japan went negative, I expect the Fed would recognize that so far, attempts by the other central banks to stimulate their economies with negative interest rates are not working and may actually be counterproductive.
What's your outlook for U.S. interest rates in the near to medium term? I think we're probably going to see the 10-year bond yield remain south of 2% and north of 1%. If I had to pinpoint it, it would be at the middle, where we are now. I expect that will last through the end of next year.
With interest rates so low, will the Fed have ammunition to fight a potential recession? Not really. The Fed was trying to replenish the ammo stockpiles late last year, but it backed off on its plans to continue to raise rates at the beginning of the year, and then completely reversed course and started to use some of that ammo in July, when it cut the fed funds rate by 0.25 percentage point, followed by another 0.25 percentage point cut in September. That leaves much less ammo when we have the next recession.
What do negative—or, in the case of the U.S., very low—interest rates mean for investors and savers? Corporate earnings and revenues have been growing. And in environments with very low interest rates, valuations have moved higher. There's a lot of stock market volatility around those basic trends—but we're not that far off from the record highs in the stock market. However, it's definitely a tax on savers. The only way negative rates make sense for a saver is if you have outright deflation.