Are Negative Interest Rates in Our Future?

Are negative interest rates in our future?

The markets are starting to think so.

On Thursday, Fed fund futures contracts began pricing in negative interest rates. They were initially priced in for December but then shifted to early 2021. This doesn’t guarantee negative rates, but it does indicate markets are beginning to expect them.

Practically speaking, if rates go negatives, financial institutions must pay to deposit excess reserves at the Fed. Normally, the central banks pay interest on funds deposited there. In effect, negative rates penalize banks for holding cash and incentivize them to lend cash out. Negative rates are designed to stimulate more borrowing to help prop up the economy.

This indicates a number of things. In the first place, it undercuts the narrative that the economy is going to quickly recover. I’ve been saying this for weeks. We’re not going back to normal. We weren’t normal before the pandemic.

The Fed was already propping up the economy with extraordinary monetary policy. We had three rate cuts last year. The Fed was running repo operations in an attempt to prop up the overnight lending markets. And the Fed had already pivoted to quantitative easing, even though they refused to call it that. The economy was showing signs of cracks before coronavirus. Anybody who thinks the economy is going to snap back to normal and start booming as soon as governments “open up” is high on Fed fairy dust. The expectation of negative rates indicates some people out there recognize this truth.

In a recent podcast, Peter Schiff reiterated this point.

If the markets are thinking that the Fed funds rate is actually going to be negative in January or February of 2021, what is that telling you about what the market is thinking about the economy in early 2021? Clearly, the market expects the economy to still be in recession. Because if the markets anticipated the economy was doing well, why would they factor in negative interest rates? It’s only because they believe the economy is not going to do well.”

The economy needs monetary heroin to keep flowing. And like every drug addict, it needs ever-higher doses of the drug. Negative rates are the next logical step.

A Bloomberg article also pointed out that the markets want negative rates to  “validate elevated stock prices that are notably decoupled from fundamentals.” The fact that stock markets keep rallying despite dismal economic data reveals the complete disconnect from economic reality.

The markets are starting to press for negative interest rates, an outcome that would make risk assets more attractive in two ways: through net-present-value effects that benefit valuations and by pushing more money out of government bonds and cash and into riskier bonds and stocks. At play here is yet again a particularly unhealthy aspect of the co-dependency that has emerged in recent years between the markets and the Fed. It is now developing ever-deeper roots. Markets that have been conditioned to think of the Fed as their BFF, quickly incorporate a positive central bank surprise and then ask for additional easing.”

Jerome Powell has said repeatedly that the Fed won’t take interest rates negative. So, why don’t the markets believe him? Because the Fed has a long history of saying one thing and doing the opposite just months later.

Remember when the Fed was raising rates and balance sheet reduction was on autopilot? It just took one hiccup in the stock market and suddenly the central bank put all that pause. At the time, Powell said the pause was temporary, but just a couple of months later, we were back to rate cuts and QE.

So, when Powell says he absolutely won’t go negative, I hear, “Yeah, we might go negative.” And that’s how the markets are thinking too.

The stock market reacted just like you would expect – it went up. Gold also saw a rally. Negative interest rates are good for gold.

If the Fed does go negative, it will likely have to keep rates there for a long time. The European Central Bank (ECB) launched negative rates in June 2014. The Bank of Japan (BOJ) introduced negative rates in January 2016. Both are still maintaining a negative rate policy today.

Negative interest rates have a perverse effect on the economy. As Mises Institute president Jeff Deist wrote in an article last year, “Negative interest rates turn everything we know about economics upside down.”

Negative interest rates are the price we pay for central banks. The destruction of capital, economic and otherwise, is contrary to every human impulse. Civilization requires accumulation and production; de-civilization happens when too many people in a society borrow, spend, and consume more than they produce. No society in human history previously entertained the idea of negative interest rates, so like central bankers we are all in uncharted territory now.”

“Bond King” Jeff Gundlach warned in a tweet that the excessive borrowing by the US Treasury is pushing rates toward the negative. Last week, the Treasury announced it plans to borrow $2.99 trillion in the second quarter alone.

These Trillions Treasury is borrowing is heavily in T-Bills. Chair Powell has stated in plain English he is opposed to negative interest rates. Yet the pressure to go negative on Fed Funds will build as short term borrowing explodes and dominates. Please, no. Rates < 0 = Fatal.”

No matter what the Jerome Powell says, negative rates are on the table. The Fed chair has already said everything is on the table. Negative rates are part of everything. And really, we’ve been on the path toward negative rates for a long time. The Fed has been walking down this road for well over a decade. When you keep rates artificially low, you have no choice but to keep pushing them lower. Each crisis lowers the bar and right now, we’re in the mother of all crises.

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