Think Positive: Three Reasons We’re Unlikely to See Negative Interest Rate Policy in the US

There has been fresh speculation that the US Federal Reserve (Fed) might implement a negative interest rate policy (NIRP) in its quest to boost the economy. While negative interest rates are not a new phenomenon, we’ll explain three main reasons why Invesco Fixed Income believes this scenario is highly unlikely in the short to medium term.

What is a negative interest rate policy?

A negative interest rate policy is an unconventional monetary policy tool that central banks use to discourage banks from holding cash by charging them a negative rate on excess reserves, thereby encouraging them to lend money instead. This, in turn, should lead to increased lending, promoting further spending by businesses and consumers, and lead to economic recovery. Denmark was the first to institute a negative interest rate policy in July 2012, followed by the European Central Bank, Sweden and Switzerland. The latest central bank to join the fray was Japan on Jan. 29, 2016.

Why is there speculation about NIRP in the US?

In January, the Fed released the hypothetical scenarios that it would be using in its 2016 Comprehensive Capital Analysis and Review (CCAR) stress test exercise for US banks. One of the new scenarios included in the test was negative US Treasury bill rates as a reaction to economic and market shocks.

The CCAR is neither a prediction nor a forecast. Rather, it is meant to assess the strength of banks and their resilience to extreme circumstances. The inclusion of the negative Treasury bill rates in the CCAR led to speculation that the Fed might follow the lead of Europe and Japan and implement NIRP in the US. As a result, Fed Chair Janet Yellen was asked about NIRP at the semiannual testimony to Congress, where she said the Fed does not intend or see the need for NIRP at this time but would not take negative rates off the table as a potential policy option. She further emphasized that NIRP is not a preferred tool for stimulating the economy and that “ … we have work to do to judge whether they would be workable here.”

Why are negative US rates unlikely?

There are three main reasons why Invesco Fixed Income believes a negative interest rate policy will not happen in the US in the short and medium term.

  1. Economic outlook. US economic fundamentals are healthy enough not to require negative interest rates, in our view. Invesco Fixed Income is calling for US gross domestic product growth of 2.4% in 2016, and year-over-year core inflation (which the Fed watches) of around 2% — nowhere near the conditions necessary to require negative policy rates.
  1. Other Fed tools available. The Fed has many other tools it can deploy before reverting to such a dramatic interest rate policy. For example, it could cut the Fed funds rate back to its previous range of 0% to 0.25%, increase quantitative easing (QE) purchases, redeploy a maturity extension program such as “Operation Twist,” and, of course, they can always use forward guidance to drive rates.
  1. Uncertain outcome. Many question whether negative interest rates would have their intended effect in the US. With a large and vibrant money market fund industry, the structure of the US money markets is vastly different from both Europe and Japan. Negative policy rates in the US could be disruptive to the US money markets, potentially creating an arbitrage between retail bank deposits and retail money market funds. This could lead to large asset flows, pushing cash back into the banking system and disrupting the money markets in general, which would not be supportive of economic growth as intended.

Read more investment views by our fixed income experts.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

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Think positive: Three reasons we’re unlikely to see negative interest rate policy in the US by Invesco Blog

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