The reasons behind the Fed’s No-NIRP stance: It doesn’t work and kills bank stocks. One of the most revealing statements.
Over the years, the Fed has waffled on all kinds of things, from what represents “price stability” to what it will do with regards to asset purchases. But there’s one theme that it has been relentlessly consistent about: a negative interest rate policy (NIRP).
There has been a lot of clamoring for negative interest rates, ranging from bond-fund managers and hedge funds – when rates fall, bond prices rise – to the White House. Last week, futures markets had started to price in negative rates for the federal funds rate, which is the rate that the Fed targets with its policies. The absurdity is just too tempting and juicy: Who wouldn’t want to be paid to borrow money?
So Fed Chair Jerome Powell came out today and hammered down those hopes, as he and other Fed governors had done so many times before. And he mentioned the reasoning behind it – including the banks!
“The committee’s view on negative rates really has not changed. This is not something that we’re looking at,” he said during the Q&A after his presentation at the Peterson Institute for International Economics. “We chose not to implement negative rates during the Global Financial Crisis and the recovery, and instead we relied, as you pointed out, on forward guidance and asset purchases when we were near the zero bound.”
“And we’ve said that we intend to continue relying on those tools which are tried, and they are now a part of our toolkit. In fact, just back in October we revisited this question, and the minutes said that all FOMC participants – and that’s not a sentence you get to say very often – that ALL FOMC participants currently judged that negative rates did not appear to be an attractive monetary policy tool in the United States,” he said.
What the FOMC minutes said.
The minutes from the October 2019 FOMC meeting – and this was in the middle of the repo market blowout – said this: “All participants judged that negative interest rates currently did not appear to be an attractive monetary policy tool in the United States.” The reasons cited were:
- “that there was limited scope to bring the policy rate into negative territory,
- “that the evidence on the beneficial effects of negative interest rates abroad was mixed,
- “and that it was unclear what effects negative rates might have on the willingness of financial intermediaries [the banks] to lend and on the spending plans of households and businesses.”
The minutes added: “Participants noted that negative interest rates would entail risks of introducing significant complexity or distortions to the financial system.”
Powell spells out the reasons behind the no-NIRP stance
“So I would say there are a couple of reasons behind it,” he said.
“One is we do feel that our tools work. The tools that we have used, forward guidance and asset purchases, work,” he said. “We’re now doing these 13-3 facilities.”
These “13-3 facilities” are the alphabet-soup bailout programs, many of them via Special Purpose Vehicles (SPVs) that the Fed sets up and lends to, and that then do whatever the Fed directs them to do, such as buying “eligible” junk bonds.
The moniker “13-3 facilities” refers to the revised Section 13, paragraph 3, of the Federal Reserve Act, as revised in 1991 and in 2010 with the Dodd Frank Act to put some limits on it.
“We think they [the 13-3 facilities] work too. So we think we have a good toolkit, and it works, and we have evidence that it works, and I think that’s what we will be using,” he said.
But those 13-3 facilities, after the initial burst in March, have languished through the balance sheet as of May 8. What the Fed has done mostly with it is jawboning.
And Powell also addressed the strategy of jawboning today. It’s the item in the Fed’s toolkit that he called “forward guidance.”
The Fed has used this for ages. It’s one of its most powerful tools to distort markets. In the Q&A, in reply to the next question, which was unrelated to NIRP, Powell addressed the success of jawboning. The “announcement effect,” he called it. Concerning the 13-3 facilities, he said:
“We frankly have helped already through the announcement effect. Markets have really loosened up and started to function much better than they were just a couple of months ago at the early part of the crisis when markets were not functioning well. So we see that. And that has enabled many companies to finance themselves now. And that’s a good thing. And it may mean that we actually aren’t needed.”
Yes, I got that last part.
“And it may mean that we actually aren’t needed.” In other words, the announcement effect – the jawboning – was so successful that the Fed may not have to actually do all that much, if anything, in terms of lending to big companies and buying their junk bonds, leveraged loans, CLOs, and other corporate stuff. The Fed might just dabble in it to maintain its credibility, and to show that it can do it without having to actually do it, as long as the credit market doesn’t refreeze.
And besides, NIRP doesn’t work and kills bank stocks.
“Also, the evidence on the effectiveness of negative rates is very mixed. There’s research that says that they’ve been effective, and there are plenty of doubters,” he said. And looking at the economies of Europe and Japan, clearly, NIRP has done nothing for the economy. “So it’s an unsettled area I would call it,” Powell said.
“And the issue really is the concern over interrupting the intermediation process [what banks do] and reducing bank profitability thereby reducing the availability of credit in the economy,” he said.
This was about the banks. While the Federal Reserve Board of Governors, of which Powell is chairman, is an agency of the US government, and Powell a federal employee, the 12 regional Federal Reserve Banks – the all-powerful FRB of New York that does nearly all the asset purchases and swaps, plus the FRBs of Boston, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco – are private corporations whose shareholders are the financial institutions in their districts.
This is a critical distinction between the Fed and NIRP-infested central banks, such as the ECB, the Bank of Japan, or the Swiss National Bank. None of them are owned by the banks. And they couldn’t care less about bank stocks, as long as the banks themselves don’t topple. And bank-stock indices for Europe and Japan have plunged to multi-decade lows.
Concerning the impact of NIRP on the banks, Powell also took it to Congress. In congressional testimony (transcript) on February 11, he said that there was “some evidence” that negative interest rates “wind up creating downward pressure on bank profitability, which limits credit expansion.”
Since the largest part of the Federal Reserve System – the 12 regional FRBs – is owned by banks, bank stocks are hugely important to the FRBs. And thanks to the Fed’s actions after the Financial Crisis, US bank stock indices largely recovered from the Financial Crisis – well, until the violent sell-off that started in late February and continued today.
“I know that there are fans of the policy but for now it’s not something that we’re considering. We think we have a good toolkit and that’s the one we’ll be using,” Powell concluded, with an eye on US bank stocks that have already been hit hard in anticipation of big losses – with the Dow Jones U.S. Banks Index having plunged 45% year-to-date. And the last thing the banks need is NIRP.