Stocks Sag as Fed Resists Slashing Rates Below Zero

A graph from the Federal Reserve Bank of Cleveland shows the expected impact over the next 12 months that the coronavirus pandemic will have on inflation (blue) and GDP (green).

MANHATTAN (CN) — Resisting intense pressure by the White House, the Federal Reserve will not cut interest rates below zero.

“The committee’s view on negative rates really has not changed. This is not something that we are looking at,” Federal Reserve Chairman Jerome Powell said Wednesday in a live telecast hosted by the Peterson Institute for International Economics

During the question-and-answer portion of his speech, Powell took a hawkish tone, saying that negative interest rates tend to interrupt the intermediation process and hurt bank profitability. “I know there are fans of the policy, but for now it is not something we will be considering,” he said.

Negative interest rates mean banks and investors must pay central banks if they have surplus cash. The move is intended to get banks to quit hoarding cash and open up lending to businesses and individuals. 

Even before the Covid-19 pandemic, President Trump had called out Powell numerous times for not slashing interest rates aggressively enough. He did so on the eve of Powell’s speech as well. “As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the ‘GIFT’. Big numbers!” the president tweeted.

Markets reacted to Powell’s speech with some negativity. The Dow Jones Industrial Average fell 122 points, a half-point percentage decrease, at the morning bell. The S&P 500 had a similar drop, though the Nasdaq remained largely flat at opening.

Earlier in the morning, U.S. stock futures had earlier pointed at investors rallying to regain some of what they had lost on Tuesday.

The Fed cut rates nearly to zero in March — eliciting brief praise from Trump at the time — but some want the central bank to go below the 0.25%–0% range.

While negative interest rates are not on the table, Powell did suggest that the central bank has other measures in mind to prop up the economy.

“A prolonged recession and weak recovery could also discourage business investment and expansion, further limiting the resurgence of jobs as well as the growth of capital stock and the pace of technological advancement,” Powell said. “The result could be an extended period of low productivity growth and stagnant income.”

To address liquidity issues, Powell emphasized that the Federal Reserve has “a good tool kit” but that liquidity problems could spiral into solvency disasters. “Over a longer period of time, more fiscal help may be needed,” he said.  

A number of Federal Reserve regional bank presidents have splashed cold water on the idea of negative rates, with the most recent announcement coming Tuesday out of Cleveland.

“I anticipate that the second quarter will show the most severe effects on the economy,” Loretta Mester said in a speech on Tuesday, noting increasing unease about the effects of Covid-19 on the economy.

“The Cleveland Fed’s national survey of consumers indicates that most respondents initially thought the virus outbreak would last less than six months,” Mester continued. “More now believe it will last one year, and a growing number think it could last two years.”

Mester called for further direct fiscal support from the central bank if unemployment claims remain at high levels and businesses start to fail. But the Fed is unlikely to change the federal funds rate from 0% to 0.25%, she said, until the economy has achieved “maximum employment and price stability goals.”

Flare-ups of coronavirus later in the year could also overwhelm the health care system and cause further instability to the banking system, Mester warned. “At this point,” she said, “I think some of the more pessimistic outcomes are almost as likely as the reasonable baseline I just described.”

In recent years a handful of countries have used the aggressive tactic of negative interest rates, including Japan, Denmark, and Switzerland. Late Tuesday New Zealand’s central bank also indicated it would look at lowering rates below zero

Whether the United States will go down that road is unclear. In an investor’s note Wednesday morning, Boris Schlossberg of BK Asset Management said lowering U.S. interest rates below zero “would wreak havoc” with the retail money market sector. 

In his remarks, Powell said he expects unemployment to peak during the next month or so but that a decline in unemployment will occur. From there, however, he warned unemployment will take “a few more months than we would like” to return to the levels earlier seen in 2019. “It will take some time to get back to where we were,” he said.

Some have worried about the breadth of the Fed’s actions, noting that the central bank had taken only recently paid off the spending after the 2008 financial crisis and now is taking trillions back onto its balance sheet.

“The Fed never went back to its pre-financial crisis stance in terms of its balance sheet and operations,” said Greg Brown, head of University of North Carolina’s Kenan Institute of Private Enterprise. “I think it’s reasonable to assume that it would take decades for monetary policy to return to anything that would look like pre-financial crisis or pre-pandemic monetary policy.”

Nearly 4.3 million people worldwide have been confirmed infected by Covid-19, according to data from researchers at Johns Hopkins University, and 292,000 have died. In the United States, more than 1.3 million people have contracted the novel coronavirus and more than 82,000 have died.

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