EDITOR'S NOTE

I had *just* gone through a whole thing about the relative merits of the Fed's corporate bond-buying program versus Negative interest rates, when the landscape has shifted again in favor of negative rates.

I don't mean the "official" landscape; in fact, as Steve Liesman reported on our show yesterday, Fed members Bostic and Evans (no relation, ha) both just voiced objections about going negative. (As Reuters put it, "Fed policymakers are negative on negative rates".) 

I mean the world of macro markets commentators, who have a way of sniffing out Things That Are Coming way before the academics and Fed policymakers themselves typically catch on to them. 

David Zervos of Jefferies this morning--one of the biggest bulls on the street about the Fed's corporate bond-buying--today wrote, "If they go negative, they go big." Zervos is "increasingly sympathetic to the idea" that the Fed will cut interest rates below zero and Congress will support it--why? In part because suddenly the "cost" of interest on our ballooning federal debt goes way down, freeing up money to be spent elsewhere, and who in government doesn't want that? 

I wrote yesterday of the myriad criticisms of negative rates, and proponents of this idea--especially those in government--will have to explain to the public why negative rates won't hurt the country more than help it. I remain highly skeptical. Several countries which have tried negative rates have either reversed it (Sweden*) or stopped at relatively shallow levels, like -0.1% in the case of Japan. 

Zervos says our Fed needs to "go big" and cut rates to, say, negative 3%--similar to what economist Ken Rogoff called for on Power Lunch last week. Zervos says if it severely damages the banks, so what? Maybe that helps the Fed's image! To which I might respond, "never do evil that good might come of it." But it's also completely at odds with government needing the banking system to reach small businesses with cash relief for Covid-19. 

In any case, the point of negative rates is to lower borrowing costs--especially for hard-hit companies--and keep the financial system from tightening. But for starters, even with negative rates, the Fed's corporate bond buying (which partly kicks off today) is still necessary--and may prove sufficient--to spur investors to take on credit risk. 

The Fed is shrinking the spread between its fed funds rate and corporate borrowing rates already to such an extent that having "negative" official rates may not be necessary. Not to mention that negative Treasury yields could happen anyway with enough global demand for U.S. assets, which would similarly lower borrowing rates. Not to mention that investors could push corporate borrowing rates negative on their own anyhow! (Why? Because they can keep selling the bonds at higher prices.) 

And for "normal"-sized businesses who don't play in credit markets but still need cheap financing right now, that's exactly what the Fed's potentially $6 trillion "Main Street" lending program is for--if the Fed ever gets it off the ground, or acts like it really wants customers.

Secondly, financial conditions have improved a lot already since the lows in March. (Michael Darda of MKM Partners can even make the case for a V-shaped recovery based on broad money growth and its anticipated velocity.) That would make this a strange moment for such a massive rate cut, especially a "deeply negative" one. 

And finally, the health of the banking system--along with the viability of insurance companies and large pension funds--is truly at risk here and that's not a good thing. Here's how The Wall Street Journal last year described Europe's experience with the negative rates: "The negative-rate policy's ineffectualness is a sign of just how weak Europe's economic engines are, and how vulnerable. The policy threatens pensions, creates the risk of real-estate bubbles and doesn't fully quell the specter of deflation. European banks struggle with weak interest income and thin margins on loans, putting them behind American peers in profitability and making it harder for them to finance the economy." 

So I absolutely expect the chatter about "negative rates" to pick up in the coming months. But I would absolutely need more evidence this is something the U.S. should pursue. 

See you at 1 p.m!

Kelly

*From the FT article linked above, which offers a good review of Sweden's experience: "Research published last year by Princeton University economists Markus Brunnermeier and Yann Koby found that many of the benefits of negative rates are front-loaded — such as gains in asset prices on bank balance sheets — while the corrosive side-effects last longer."

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