Small Business Financial Article
Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.

The Possibility of Negative Interest Rates in the U.S.

The Possibility of Negative Interest Rates in the U.S.

The recent cut in the federal funds rate to near zero is causing concerns that interest rates in the U.S. could go negative. As of March 30, 2020, the three-month Treasury yield is a negative 0.06%, and the 10-year yield is 0.75%. As the economy slips into a coronavirus-induced recession, there are growing concerns about negative interest rates across the board. What are negative rates, and how do they work?

What are Negative Interest Rates?

A negative interest rate environment is like the Bizarro World of finance. With negative rates, lenders pay borrowers for the privilege of lending them money, and savers pay banks for the privilege of storing their money. Bonds issued by the government and some corporations carry negative yields to maturity. Even a few “high yield” bonds carry a negative rate. That means the price investors pay for negative-rate bonds is higher than the face amount they will receive at maturity. In other words, investors are guaranteed to lose money.

How Negative Interest Rates are Working in Europe

In a last-ditch effort to boost the European economy, the European Central Bank (ECB) forced short-term interest rates below zero in 2014, where they remain today. That means the ECB is paying negative interest on deposits made by commercial banks. In other words, because the rate is negative, instead of paying interest, the central bank is receiving interest. The ECB’s objective is to incentivize banks to keep more of their money working through loans and investments from which they can earn a higher rate of return while having a stimulative ¬†effect on the economy.

While there are a few reasons why investors would own negative-rate bonds – i.e., fear of rates going more negative, fear of recession, fear of deflation – there are few investors who would willingly lock in a negative return. And, rather than lifting demand by encouraging borrowing and spending, negative rates are driving consumers in Europe to save more (earning negative returns) out of concern for an uncertain future. In this way, negative rates may have a contractive rather than a stimulative effect.

The Possibility of Negative Rates in the United States

When considering the possibility of negative interest rates in the United States, monetary experts are quick to point out that the United States is not Europe. There is much to differentiate in terms of economies, financial systems, market behavior, and legalities.

Monetary experts question whether a cut to subzero levels would have sufficient stimulative impact to warrant the possible consequences. At risk would be the disruption of money market funds (MMF), which play a significant role in short-term funding markets. Should MMFs be forced to “break the buck” by lowering their net asset value price below a dollar, it could cause a squeeze on short-term funding. It has yet to be explored how long banks would hold out from charging retail customers for deposits. If that were to occur, it is uncertain as to how long retail customers would hold out from withdrawing their cash.

Finally, there are legal issues in the United States concerning the Federal Reserve’s ability to pay negative interest rates. The language in the Federal Reserve Act doesn’t necessarily prohibit it. Still, there is nothing in its language that allows it. Attempts by the Federal Reserve to move in that direction could be tied up in courts for years.

The European experiment is more than five years old. But the data suggests that, while negative rates have yet to do any real harm, they are only having modest success in stimulating economic growth.

The more conservative Federal Reserve Board would likely need more concrete evidence that the benefits of a negative interest rate would substantially outweigh the potential risks before considering it as a viable monetary tool.

Read Other Small Business Financial Articles