Legal and practical obstacles make negative rates unlikely, but Janet Yellen suggests such a move is possible
Federal Reserve Chairwoman Janet Yellen waded into fraught territory before Congress, suggesting the central bank could turn to negative interest rates in an economic downturn despite legal and other uncertainties.
Her comments Wednesday came as concerns about unsettled markets and weak global growth pushed benchmark U.S. Treasury rates to a one-year low. The yield on the 10-year note fell to 1.706%, leaving it down more than half a percentage point so far this year.
Central banks in Europe and Japan have turned to the once-radical idea of negative interest rates to spur their moribund economies. The idea that their U.S. counterpart might follow suit is unlikely but not impossible. The Fed raised interest rates in December for the first time in a decade and is weighing whether to raise them further. Ms. Yellen in her testimony said it was unlikely the central bank would need to cut rates soon, much less go negative.
When questioned about the possibility, however, she said it could be done if necessary.
“I’m not aware of anything that would prevent us from doing it,” Ms. Yellen said.
That the question even comes up is a sign of the bind central banks find themselves in seven years after the financial crisis. Growth remains weak, and investors have retreated from risky assets this year, putting pressure on monetary-policy makers to find more aggressive ways to stimulate demand.
The Janet Yellen adopted negative rates in January, following the example of the European Central Bank and policy makers elsewhere in Europe. Countries representing more than a fifth of global economic output now are experimenting with negative rates.
Fed officials are taking the idea seriously after watching the efforts overseas. Negative rates are “working more than I could say I expected” only a few years ago, Fed Vice Chairman Janet Yellen said this month. The Fed said in recent materials related to its annual bank “stress tests” that big financial institutions need to model how they would perform under negative borrowing costs.
The prospect would face a number of challenges. A central impediment is the law authorizing the Fed to pay interest to banks on reserves they deposit with the central bank. The Fed now is paying 0.5%, a rate it moved up from 0.25% in December in hopes the economy and job market would keep improving.
The 2006 law granting the Fed that authority says depository institutions “may receive earnings to be paid by the Federal Reserve.” That language—“to be paid”—might prevent the Fed from charging interest on deposits without new legislation from Congress. The Fed looked at the legality of negative interest rates in 2010 but didn’t reach firm conclusions, Ms. Yellen said Wednesday.
“We would need to see recession-like conditions before the Fed seriously considered this option,” Michael Feroli, an economist with J.P. Morgan Chase, said in a recent note to clients.
Meanwhile, the yield on the 10-year U.S. government note fell after an auction of government debt Wednesday drew strong demand from investors at home and abroad. Investors accepted a 1.73% yield on new 10-year Treasury notes, the lowest auctioned yield on that maturity since 2012.
Those results reflect investors’ struggle to obtain assets that offer a good mix of safety and income. Thanks to negative rates elsewhere around the globe, U.S. Treasury bonds offer some of the highest yields in the developed world.
“U.S. yields are still much higher than many other peers, creating demand,” said Mary Ann Hurley, vice president of trading at D.A. Davidson & Co. “There is no inflation, and the global economy is struggling.”
Should the economy sink, some economists say the Fed will have no choice but to find a way around the impediments to engineering negative rates.
In almost any likely recession scenario, the Fed won’t have been able to raise rates high enough to then lower them enough to provide real economic lift, said Scott Sumner, an economics professor with George Mason University’s Mercatus research center. So to get there, the Fed will have to go under zero with its short-term rate target, he said. “When we next go into recession, we’ll go negative,” he said.