With the federal funds rate anchored just above the zero level and the Fed already deeply involved in large-scale unconventional monetary policy programs (e.g., QE), many investors wonder when Negative Interest Rates (NIRP)will become a reality in the United States. Or is it even possible to think of that?
To start with, it seems unlikely for numerous reasons. Firstly is that the Fed have always suggested that NIRP has so far not been on the table, nor has it ever been in the past. Yet this can change in a blink of an eye, providing the Fed is shocked by further economic downturns.
Another one is that the USD is not just a regular currency, but the world’s reserve currency. Many foreign nations choose to hold a big chunk of their foreign reserves in USD, with massive implications for treasuries around the world if the federal funds rate drops below zero.
Between Two Evils, NIRP in the United States Is Preferred
As the Fed raised the rates in 2018 and 2019 from zero to well over 2%, it became increasingly difficult for emerging markets to service their debt. As a side note, most debt in the world is issued in USD – so when interests and principal are returned years later, a higher USD certainly impoverishes emerging markets more.
The USD as the world’s reserve currency sits at the heart of the international financial system as we know it. One of the first Fed’s moves during the pandemic was to open dollar swap lines in coordination with other central banks around the world. In other words, it provided USD liquidity internationally.
The current health crisis has the power to challenge the financial system as we know it to the core. Unless the USD becomes readily available and cheaper by all standards, the world may not cope with the economic shock induced by the coronavirus otherwise.
The actions of the Fed so far mostly addressed the US economy, in an “America First” approach. Moving the federal funds rate into negative territory would assist larger capped emerging economies, as the implicit lower USD helps to batter the crisis.