In early March 2020, amidst the realization that the Coronavirus pandemic was going to remain a major medical, social, and economic health risk, the US Federal Reserve slashed the fed funds rate target to 0-0.25%. Investors were then soothed by Fed guidance in June that interest rates would remain near zero through 2021 and likely into 2022. As Chairman of the Fed, Jerome Powell, put it, “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,”. (1) Here we are, a couple of months later with the S&P 500 reaching all-time highs. It’s clear that stock investors -at least for the near term- really liked Powell’s commitment to keep the cheap money flowing! Some are beginning to worry, however, that should the US economy suffer another shock, the Fed will have nowhere to go but down further to negative rates. Read on to find out what a world of negative rates could look like for the economy and, most importantly, for your bank account.
Should we ever delve into the Stranger Things-esque “Upside Down” of negative rates, we wouldn’t be the first central bank to do so. In fact, the eurozone, Denmark, Sweden, Japan, and Switzerland have all already donned their head lamps and hazmat suits and taken the plunge into negative rates starting back in 2009 when Sweden dropped rates below 0% as a “short term” jolt for a waning economy and then, more broadly, in 2014 following the Euro debt crisis. The aim of negative rates is similar to that of our current policy of a 0% fed funds rate; to spur spending and investment. The difference is that large institutions that park cash with central banks that have adopted a negative rate policy are not just incentivized, they are literally penalized, for holding on to cash. The logic behind this is clear. If a bank would be penalized to hold on to money, it would nearly be forced to lend it out. So, does this work as planned? The consensus is that we’re not sure. “I would say the evidence on whether it actually works is mixed,” said Jerome Powell when asked about the effectiveness of a negative rate policy. A country’s monetary system is extremely complex with many moving pieces. The experiment of negative interest rates just hasn’t been run long enough to fully grasp the effectiveness. Critics of negative rates feel that banks are actually less likely to lend in that environment. Banks are reluctant to pass on negative rates to their consumers by charging interest on a checking or savings accounts in fear that the saver will do something that large banking institutions can’t do. Hold on to cold, hard cash. A reduction in profits from bank consumers could mean that a bank has less ability to withstand risk, making them less likely to lend. (2) Others say that banks that do decide to lend out additional capital will chase increasingly risky opportunities which could increase the chance of major bank failures like we saw in 2008. Still others (there are a lot of critics!) feel that negative rates only work as a very short-term solution to nudge forward a slowing economy. A European Central Bank economic bulletin released in March 2020 said that, “The detrimental impact on net interest margins is likely to be more significant as rates remain low for longer.”. (3) To no one’s surprise, except for Sweden which returned to a rate of 0% in early 2020, central banks that adopted a policy of negative rates have not brought rates back positive.
The question that I’m asked most often by my clients regarding negative rates is an understandable one. “How will it affect me?” As I mentioned earlier in this blog, for the most part, checking and savings account holders like you and me have been mostly shielded from negative rates by the banks themselves. Some smaller banks in Germany and Switzerland have passed on the negative rates to their customers. (4) Typically, they do so in a tiered manner, with the negative rates only impacting large deposits. Of course, the money in our bank accounts won’t be the only thing affected by negative rates. In the US, we’ve already seen how a reduction in rates has impacted loans like mortgages. In a negative rate environment, things can get even crazier. In 2019, Jyske Bank, the second largest bank in Denmark, offered a 10-year, fixed rate loan at -0.5%! (5) You read that right, the bank is actually paying people to take their money. “Upside Down” indeed.
So, are negative interest rates coming to the US? Both former Fed Chair, Janet Yellen, and current chair, Jerome Powell, have stated that it’s not off the table. But with the massive size of the money-market system in the US along with the dollar being held as the world’s reserve currency, I think we would need to see an even steeper drop in economic output than we did with COVID to justify a decision to go negative. Still, it is best to be prepared, and we at Innova Wealth Partners can help you create a plan and portfolio to keep you on track with market and policy uncertainty in mind.
1. www.wsj.com – Fed Debates How to Set Policy for the Post Pandemic Economy
2. OECD Economics Department – Do negative interest rates in the euro area hurt bank profitability?
3. ECB Economic Bulletin
4. www.bloomberg.com – German Lenders Drag Retail Clients into Fray of Negative Rates
5. www.ft.com – Denmark’s Jyske Bank imposes negative interest rates
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