While Negative US Interest Rates Are Possible, Odds of Reality Look Less Than Zero

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The 30-day fed funds futures prices also offer some added insight into where interest rates will be in the months and even the years ahead. Out to January of 2021, the fed funds futures prices on August 12 were indicating that fed funds would not likely be under 1.00%. The effective range of 1.00% to 1.25% looks likely to be the case from June of 2020 through December of 2020. That can of course change, and it could change rapidly if conditions get worse than currently expected.

While negative interest rates indicate a forced loss on the surface, that’s the implication if there is not “even worse negative rates” ahead. If a central bank’s notes are longer-dated, and the (theoretical) current yield is −0.30%, there is nothing that would prevent a central bank’s policies for short-term rates the financial markets’ price mechanism from forcing that rate down to −1.0% or even lower ahead. Instead of buying and holding to maturity, a bond/note holder could sell the bond at a premium (or profit) to the price paid to new buyers down the road. It’s the “theory of the greater fool” on steroids.

There are also some theoretical issues around how this would play out in taxes in the United States. It’s one thing to have capital gains turn into capital losses in investing, but imagine the investing public reporting billions or trillions of dollars in negative interest rate coupon payments on their taxes. This is simply unknown territory in the United States.

Imagine if nonsovereign debt were to come with negative interest rates. Where things get really complicated in a scenario of negative interest rates would be around when corporations, banks, municipalities and even mortgages would trade with negative interest rates. Would people dare pay money to a corporation just for the privilege of getting less money back in the future? Would mortgages actually be paying a borrower to take out a mortgage and live in a home? In Europe, during the prior period of quantitative easing, there have been some isolated incidents there and in Japan where those scenarios were real.

In the wake of the Great Recession, the Federal Reserve maintained a policy of zero interest rates (ZIRP) but it did not embark on a policy of negative interest rates (NIRP). That said, there were some inflation protection Treasury issued TIPS that did price with negative interest rates during the recovery.

The goal of negative interest rates is to put economic stimulus on steroids. If a lender or a corporation believes it will be forced into a loss on holding cash, then they will be incentivized to put that money to work via loans, capital spending or other means of spending to incentivize income. There is no simple answer when it comes to who really pays under negative interest rates, but on the surface it seems everyone really pays when there are such rates.

A Federal Reserve white paper from 2016 predicted how U.S. banks would fare under a period of negative interest rates. The conclusion, some 25 pages in, suggests that one-third of banks would expect their earnings to be negatively affected and one-third would expect bank earnings to be positively affected. In 2015, one FOMC member did at least suggest that banks might need to prepare for negative rates. A fresh view from PIMCO also shows how banks would be paying for excess reserves.

This debate over negative interest rates is a debate that simply has no end. And the answer in determining who ultimately pays the price for negative rates — well, that just depends on the circumstances. Regardless of the debate, negative rates sound very supportive of gold and companies that are believed to have safe and solid dividends regardless of each business cycle.

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