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Can the Fed Drop Interest Rates Below 0%?

This question is not as preposterous as it may seem.

For the financial markets, the biggest event of the week starts tomorrow: On Wednesday and Thursday (Feb. 10-11) Fed chair Janet Yellen will appear before Congress to deliver her semi-annual Monetary Policy Report.

"It's huge." That's how one strategist put it this morning, in a CNBC interview about the importance of Yellen's testimony.

Why are all eyes on Yellen? Maybe because by now, almost everyone has forgotten how powerless the Fed appeared in 2007-2009, when none of its measures could stop the financial crisis. Despite the recent market chaos, six years of rising stock prices reaffirmed the notion that the Fed can move mountains. "As the Fed goes, so do the markets" is the current mantra -- so, on Wednesday and Thursday, analysts will be listening carefully: Will Yellen mention the ongoing market turmoil?

If not, then the Fed is focusing on "the positives" like the U.S. jobs and GDP numbers, which makes another interest rates hike likely in March. If Yellen does mention the "turmoil," then the Fed is worried about the markets, making a March hike unlikely.

Basically, it comes down to "rate hike now" -- or "rate hike later." But there is the third option.

A rate cut. And not just any cut, but a rate cut below zero.

Crazy? Look at Europe and Japan, where negative interest rates are already in place. As our December Financial Forecast wrote,

"...yields on more than one-third of all euro-area government bonds...are now below zero.

"A buyer of these bonds at par who holds them to maturity is guaranteed to lose money."

Can this happen here? Yes, says Bloomberg:

"Fed Chair Janet Yellen said in September that negative rates weren't a main policy option, but that officials would evaluate the approach if needed."

Translation: "Fed officials have said negative rates are possible, though not probable any time soon."

What could push the Fed to make a move like that? Our new, February Financial Forecast explains:

"Successive rounds of quantitative easing by central banks along with various other monetary tricks were all designed to spark inflation; all they utterly failed.

[That's hard to argue with: Europe is officially in a deflation, and the Fed has been unable to push inflation up to its goal of 2% for several years. -- Ed.]

"The latest gambit to grab the fancy of central bankers is negative interest rates. Japan [has just joined] the European Central Bank, Sweden, Denmark and Switzerland in charging depositors to hold their money.

"These actions confirm that deflationary forces are intensifying, consistent with our long-standing forecast. It may seem outlandish to think so at the moment in light of the U.S. Federal Reserve's recent decision to raise short-term interest rates, but deepening deflation will eventually force the U.S. central bank to go down this path, too."

If the Fed indeed is forced to reverse course and drop interest rates below zero, what investment will be a "safe place"?

Read our new report, Risk ON? Risk OFF? Find Out Where Your Money Lies. The editors of our Financial Forecast Service, Steve Hochberg and Pete Kendall, have been tracking a "steady global shift to greater financial conservatism over the last 18 months." They have just published this new report detailing all of their findings. Read Their Complete Report >>

 


This article was syndicated by Elliott Wave International and was originally published under the headline Can the Fed Drop Interest Rates Below 0%?. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

 

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