Why negative interest rates are 'seriously dangerous': strategist

Iryna Kirby · Senior Producer

Updated Thu, Sep 12, 2019, 10:42 AM

Trump call for negative interest rates

On Wednesday President Trump resumed his attack on the Federal Reserve, calling Fed Chair Jerome Powell and other members “boneheads” for not driving “our interest rates down to ZERO, or less.” Trump explained that he wanted negative rates in order to refinance the outstanding $22 trillion in government debt and lengthen the term.

“Trump is thinking about negative rates from the perspective of a borrower,” Capital Economics Chief U.S. Economist Paul Ashworth wrote in a note to clients. “But the Fed’s lukewarm appetite for negative rates is partly because officials know that it could cause outrage among savers and drag the central bank into a political maelstrom.”

How do negative interest rates work?

Typically banks will pay depositors an interest rate for keeping their money with the bank. With negative interest rates, these depositors actually pay the banks a nominal rate to store their money instead of getting paid. Similarly, with government-issued debt, global investors also pay money to hold a bond with negative yields because the premium that they initially paid for it exceeds the total interest they receive over the life of the bond.

Historically negative interest rates have been used as an anti-recession tool for sputtering growth in weaker economies that have historically undershot inflation expectations. However, over the past few years this phenomenon has become much more common. In fact, Bank of America estimates the market value of negative-yielding debt over the world has shot up to $16 trillion.

Bank of America Merrill Lynch estimates the market value of negative-yielding debt over the world has shot up to $16 trillion. Source: Bank of America Merrill Lynch via Bloomberg.

Risk of negative interest rates

With economic growth around the world slowing down in recent years, central banks have been forced to get creative with their monetary policy tools, including turning to negative interest rates. But a slew of Wall Street strategists have been ringing alarm bells about the potentially negative consequences of negative-yielding debt.

Japan, France and Germany lead the share of negative yielding debt globally.

Bank of America Merrill Lynch analysts call negative rates “a growing concern in developed markets.”

“Markets have gone into risk-off mode, pushing DM rates ever lower as investors flock to safe-haven assets,” Bank of America Merrill Lynch Global Economist Ethan Harris wrote in a recent note to clients. “The risk is that DM yields continue their race to the bottom, inflating a bond-market bubble that poses yet another risk to the global economy.”

Similarly analysts at J.P. Morgan, in a recent client note, wrote, “There is little doubt that negative yields are causing a distortion in the pricing of duration and credit risk as pension funds and insurance companies are forced to move further up the maturity and credit curve to avoid negative yields.”

Lookahead to Fed meeting next week

Interest rates will be front and center next week when the Federal Reserve holds its two-day September policy meeting with the decision on rates expected on Wednesday. The market is currently pricing in a 88.8% chance of a 25 basis point rate cut.

The Fed’s expected easing will come on the heels of its European counterpart, the European Central Bank, announcing on Thursday a new bond-buying program and lowering its deposit interest rates further into negative territory - a move that prompted praise from President Trump on Twitter.

“European Central Bank, acting quickly, Cuts Rates 10 Basis Points. They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports.... And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!”