President Donald Trump now wants the Federal Reserve to lower interest rates to zero or below. But he should consider the minuses of negative rates, which have failed to spur strong growth in Europe and Japan and would likely cause a firestorm among U.S. savers.
Stock-market investors, meanwhile, should note that this month’s rally has come while bond yields have reversed part of their recent sharp declines.
In his latest broadside against the central bank, Trump tweeted Wednesday: “The Federal Reserve should get our interest rates down to ZERO, or less, and we should then start to refinance our debt. INTEREST COST COULD BE BROUGHT WAY DOWN, while at the same time substantially lengthening the term.” The president concludes by calling the Fed “boneheads” for not following other central banks to negative rates.
That’s the view of the self-proclaimed King of Debt. “As a highly leveraged property developer, Trump is thinking about negative rates from the perspective of a borrower,” writes Paul Ashworth, chief U.S. economist at Capital Economics.
But the Fed has been lukewarm at best about such a possibility, “partly because officials know that it could cause outrage among savers and drag the central bank into a political maelstrom,” he adds. Money-market funds also could see large-scale outflows, which could disrupt short-term funding for businesses, banks, and perhaps even the Treasury.
Moreover, the record of negative rates in the euro zone, Sweden, Denmark, Switzerland, and Japan has been mixed, Ashworth continues. While bond yields have fallen below zero, banks been reluctant to impose negative rates on depositors, resulting in a squeeze on their profits.
Trump thinks the U.S. deserves to have subzero interest rates since it has “a great currency, power, balance sheet.” In fact, negative interest rates reflect the economic torpor in Europe and Japan. By contrast, U.S. interest rates were at their peak in real terms (that is, after adjusting for inflation) when it was “Morning in America” in the mid-1980s.
Long-term Treasury bonds briefly touched 14% in May 1984—a full 10 percentage points above inflation. Now, real yields on Treasury inflation-protected securities are just above zero. The 10-year TIPS yields 0.14% while the 30-year TIPS yields 0.56%. After taxes, which are levied annually on the inflation adjustment, those yields already are below zero.
Unlike last year, Trump’s Fed bashing now seems unfounded. Last October, when the central bank was in the process of raising its policy interest rate and shrinking its balance sheet, and the stock market was headed into correction territory, I wrote that the president had a point in criticizing the central bank for being too tight.
Now, the Fed is poised to cut its federal-funds target rate from the current 2%-2.25% range at next week’s meeting of the Federal Open Market Committee. The fed-funds futures market puts an 88.8% probability of a cut of 25 basis points—one-quarter percentage point—then, and a 72.3% probability of a further reduction of 25 basis points or more at its December meeting. The Fed also has ended the shrinkage of its balance sheet.
Meanwhile, the stock market has been rallying, with the
retaking the 3000 level Wednesday for the first time since July 30. That left the benchmark just 0.82% shy of its record and up 2.54% since the start of the month. The
Dow Jones Industrial Average
was just 0.81% away from its all-time high,
September’s rally also has been marked by an even more remarkable rotation from the market’s previous winners, notably dividend-paying, slow-growing defensive stocks, to beaten-down value stocks.
While bond yields have moved off their lows in recent days, with the Treasury 10-year note trading at 1.749% late Wednesday, up from 1.461% on Sept. 3, that’s coincided with the stock market’s September rally, which has been led by industrials and financials. A more upwardly sloping yield curve also is a positive economic sign.
Be careful what you wish for when calling for zero or negative interest rates, Mr. President.
Write to Randall W. Forsyth at email@example.com