Bloomberg tells us that JP Morgan has issued a report that contends that the Federal Reserve will cut its policy rate to zero by early next year.
While this may prove to be correct, it certainly isn’t an obvious move. First, most central banks regard getting below 1% short term rates is dangerous territory. ZIRP (zero interest rate policy) let to a deflationary trap for Japan, and there isn’t a particularly good reason to think it will fare better here.
In addition, once short term rates fall below 1%, money market funds have trouble operating profitably. The Fed may find itself not merely acting as a big player in the commercial paper market (money market funds are big buyers of CP), but becoming the ONLY player. That would also not be good.
The U.S. Federal Reserve will probably cut interest rates to zero percent over the next two months to staunch deflation, according to JPMorgan Chase & Co.
The Fed will lower borrowing costs by 50 basis points at each of the next two policy meetings on Dec. 16 and Jan. 28, JPMorgan economist Michael Feroli wrote in a note to investors yesterday. The central bank will hold rates at zero for the rest of 2009 to prevent prices from spiraling down as companies cut jobs and banks reduce lending, stifling spending, Feroli said.
The Fed may not be the only central bank to begin offering free money to jolt life into their recessionary economies and keep prices rising as the 15-month credit crisis deepens. The Bank of Japan cut its benchmark rate to 0.3 percent last month, and the European Central Bank has signaled it’s ready to lower rates further after two reductions in the past six weeks.
U.S. consumer prices plunged 1 percent last month, the most since Labor Department records began in 1947, the government said yesterday. Some Fed members indicated a willingness to cut rates to spur growth and keep prices from falling, according to minutes from the last Federal Open Market Committee meeting that were released hours after the price report.
“Taking the target rate to zero percent would not be costless for the Fed,” Feroli said. Public confidence may drop “if there is a perception that the Fed has `run out of ammo.”’
Fed officials cut their forecasts for inflation and growth at the Oct. 28-29 meeting. Some members saw a risk that the inflation rate will fall below the Fed’s objective of “price stability.”
Feroli said cutting the key rate to zero from the current 1 percent wouldn’t exhaust the central bank’s tools. The Fed could become “more aggressive” by purchasing the debt of Fannie Mae, Freddie Mac and other government-chartered mortgage financing companies, Feroli said.
“The path of least resistance may be for the Fed to first communicate to the markets that the nature of the current economic woes should keep rates low for an extended period,” Feroli said.
While not saying whether rates would be cut to zero, a Reuters story said that the minutes of the last FOMC meeting pointed to a desperation-driven willingness to drop rates below 1%. Persisting in a course of action that is not working is not a sign of intelligence. The Fed is clearly pushing on a string. Throwing its weight behind a big stimulus package before year end would be a much better way to boost the economy. If Fed funds at 1% and massive fancy facilities is not inducing banks to extend credit, a further reduction in policy rates won’t have any impact.
The Federal Reserve seems almost guaranteed to wade into unchartered waters in December and cut its benchmark lending rate below 1.0 percent.
Unrelenting bad news on the U.S. economy, reflected most recently in minutes from the Federal Open Market Committee’s October policy meeting issued on Wednesday, suggest another interest rate cut is in the works, even as rates approach the so-called “zero bound.”
“Some members were already feeling that additional policy easing could be appropriate … given recent data and developments in financial markets, ‘some’ may have turned into ‘most,” said Rudy Narvas, analyst at 4CAST Ltd in New York.
Short-term interest rate futures fully price a cut in the fed funds rate to 0.5 percent from 1.0 percent at or before the Dec 16 policy meeting.
The effective fed funds rate averaged 0.63 percent in May 1958, the lowest level shown by Federal Reserve Board records dating back to 1954.
The FOMC cut the rate to 1.0 percent in October, the latest move in an easing cycle that started in September 2007, when the funds rate was 5.25 percent, as the central bank attempts to pump life into the U.S. economy.
Sky-high futures prices also reflect ideas that the cash funds rate will continue to trade below the target rate. Cash fed funds last traded at 0.3125 percent.
Although some policy-makers have noted technical problems in cutting the target rate below 1.0 percent, opposition could melt away in the face of current economic reality…
Wednesday’s FOMC release included updated forecasts, assembled at the Oct 28-29 meeting, that pointed to a long if not necessarily deep economic recession.
“While some expected an improving financial situation to contribute to a recovery in growth in mid-2009, others judged that the period of economic weakness could persist for some time,” the Fed said.
The Fed lowered its “central tendency” forecast range for 2008 gross domestic product growth to between zero and 0.3 percent from June’s 1.0 to 1.6 percent. Some at the FOMC said the economy could shrink by 1.0 percent in 2009 with the jobless rate as high as 8.0 percent versus the current 6.5 percent.
Even those assessments, cobbled together in the final days of October, might need to be lowered given the recent labor market deterioration that will only feed the vicious cycle of negativity.
The negative 1% as worst case is also a tad optimistic. Countries that suffered financial crises as big as ours saw a fall in GDP of 1!% for two years running, and their crises did not occur in the context of a synchronized global slump.
All you need to do is eliminate immigration into the USA for 2 years and the economy will heal. My impression is that Yves,\ is a big fan of trickle up economics, where 95% of the US public suffer, work, and die for the elitists with High End apartments.
END IMMIGRATION NOW!END UNEMPLOYMENT NOW!
Anonymous, the immigrants are leaving the US voluntarily. Things are that bad.
Yves, for practical purposes we are at zero, given the 75 bps or so that the Fed charges on those borrowing from them… effective fed funds are around 35 bps. Not much room left to cut, not that it matters, because monetary policy is being done via discretionary quantitative easing… cramming favored markets full of liquidity, while everyone else is hung out to dry.
Anon of 1:01 AM,
If you think that, you have a great deal of trouble with reading comprehension.
If we’re already in string-pushing territory, why bother lowering rates? Just print. DIP financing looks like a promising new channel.
Remember that old EF Hutton commercial? Two people dining in a restaurant, and one says, “Well, my broker is with EF Hutton, and EF Hutton says…” and all the other diners stop, cupping their ears to hear?
Times have changed. If they made that commercial now, when the guy says “Well, JP Morgan says….” the other diners would all go silent, give him a blank stare, until a voice from afar says, “Who gives a f*** what JP Morgan says?”
But thanks for passing it along, Yves. Your blog is the best one going.
Won’t a ZIRP make money market funds uneconomic? That doesn’t seem like the best thing to do at this point in time.
how does a ZIRP make money market funds uneconomical? unfamiliar territory for me.
Here’s something I’ve wondered for a few years now.
I’ve always head that the Fed cannot lower nominal interest rates below zero percent. But I don’t understand what would prevent them from doing so.
Why couldn’t the fed make loans where they give out $100 today, and accept $90 in one year as complete repayment. This would be a simple -10% interest.
Is there any mechanical reason this wouldn’t work?
This headline in from The US BrainTrust:
Fed sees economic woes persisting into next year
>> Cutting edge stuff there, for Joe The Plumber and probably Obama too.
@ Alex: It just seems like a MM fund would have to break the buck if it charges any sort of management fee under a ZIRP.
To Zionist Domination:
Many Jewish households have microwave ovens in their kitchens. They are all aiming them at you. Add more tin foil to your hat.
Is there a full moon or something tonight?
I’m in Cleveland and well, the sky isn’t clear for months so I have no idea, but this thread has me wondering.
Hey Zionist Domination, some corrections for you
FRB of New York: Timothy F. Geithner – Not Jewish
FRB of Philadelphia: Charles I. Plosser – Not Jewish
FRB of St. Louis: James B. Bullard – Not Jewish
FRB of Kansas City: Thomas M. Hoenig – Not Jewish
FRB of Dallas: Richard W. Fisher – Not Jewish
I guess you have been so dominated that you think everyone is Jewish. Try finding some facts before posting.
Banks aren’t lending ’cause a) they’re broke, and b) they can’t remotely take on any more risk. Given downward pressures on demand _and_ tight and expensive credit from the banking system, the amount of stimulus it would take to _PUSH_ that string into motion is in the $2T range by many quite reasonable estimates. That much stimulus may be good for the economy of the nation but it would be quite BAD for the state of the nation, the Federal state and its currency that is.
What to do, what to do? Obviously the Feddie heads are well beyond panic and deep into denial in their mookishness about holing the zero. Worthless in the above context, and a high cost in other respects, not least demonstrated incapacity of effect. I have been of the view for some time that the government needs to lend, sensibly, into the real economy, as well as spend, generously into the public economy of infrastructure and health. The point isn’t just to print and throw zeros at Friends of the State; that often just leads to a rake-off and less than potent effects a la Paulson’s ping-not-bang for the $350B he has rushed out the door.
Whether by taking over the major banks and using them as a vehicle to lend, or creating a public agency, this purchase of commercial paper should be formalized, and directed at the real economy which can’t get funds for normal operations at credible rates. We get more bang for buck lending to established businesses to produce and hold up employment than by letting big banks take the money, pad their capital, and speculate. Yes, this smells of an industrial policy, that the government would, within credible criteria, determine who to lend to at ‘below market rates’ given that the market is skewed and dysfunctional. Paulson and the think-a-likes it looks like the new Administration is most likely to employ would rather give the money to alpha banks and beg them to do the right thing by the nation. We’ll all freeze in Hell waiting for that day to come. So let’s do an end around. Details on this matter, but the concept is what has to get off the ground first.
Sez I: Gads, how a quasi-anarchist wraps statist socialism around his principles in a crisis. I mean, I’m all for us growing Victory Gardens, but most folks aren’t going to send their children to university on the proceeds, so one has to think big, here.
I am probably getting all these terms mixed up, but I read that the FED was now paying banks 1% interest on their (the banks) reserves. Now, if the banks borrow from the FED at 0% interest, and get paid 1% interest, I have 1 question:
How do I become a bank?
there is an error in para 2 where you say “ZIRP led to a deflationary trap in Japan.” Obviously you meant to say that “a deflationary trap in Japan led to ZIRP.”
Or maybe you think interest rates in Japan were too low? They could have kept interest rates higher so as to maintain flexibility on cutting them later?
For all intents and purposes, the effective interest rate is at zero. I mean, officially the rate might still be above ground, but practically speaking, with all the new lending programs that have been instituted in the wake of this crisis, it’s pretty remarkable for people to stay talking about the official rate, core inflation, etc. Officiality does not preclude reality.
I agree with PeakVT that Debtor in Possession financing would be a great thing for the Fed to get into. Companies are afraid to BK because they can’t chapter 11 when banks refuse DIP but have to go chapter 7, and there’s a lot of that going on. If the business is fundamentally sound, just carrying too much debt, chapter 7 is a big waste because the functional business will be destroyed.
John Haskell – nominal interest rates need to be maintained at a non-trivial positive rate because otherwise, regardless of other economic conditions, there’s no reason to lend money; the credit market collapses; and the economy will then proceed into deflation from credit destruction. You need deflation to maintain the liquidity trap, true; but the trap creates its own.
The whole thing is silly. ACTUAL Fed Funds Rate is hovering around 0.3%. The Fed will cut the target to 0.5% in Dec and then 0.25% in Jan, but this isn’t really a cut, it’s just bringing the target in line with the actual. By end of January, the target will be 0.25% and the actual will likely fluctuate in the 0.1 to 0.2 range. There’s no need or point in going all the way to 0. In a deflationary environment, which is upon us now, the difference between a nominal rate of 0% or 0.25% is irrelevant. The Fed has been focused on quantitative easing rather than interest rate policy for awhile now. If anything, they will soon shift away from quantitative easing (what good does it do to flood banks with reserves if they just sit on them) and towards massive expansion of their direct lending facilities (e.g., CP) soon.
The effective rate has been under 1% for over a month, averaging .5%, but sometimes .25%. Right now it’s .38%
Poole was interviewed on Bloomberg and opined that this was an unannounced policy shift. Calulated Risk has a post up about it.
Maybe the Fed should pay banks to loan money from it :) it is getting ridiculous
As a radical economist that has been waiting 40+ years for this meltdown I applaud the demise of the greedy and corrupt system we have. I can only hope that the excesses that got us here are fully weeded from the revised economy that rises from the ashes.
Thanks for your reporting Yves. It sure is sickening to see all the flailing and denial as the house of cards comes down.
The Fed still has a gun with virtually unlimited power. It is euphemistically known as “quantitative easing”. The Fed has sneakily started using it. It will be interesting to see when they will decide to use its full force.
is a link on QUANTITATIVE EASING and the Fed
I don't like antisemitic crap either, but I still like to get the facts right.
> FRB of New York: Timothy F. Geithner – Not Jewish
According to Wikipedia, Tim Geithner was born to a Jewish family.
As for effective Fed funds rates, the Fed historically has been able to manage things to keep effective FF somewhere within hailing distance of where they want it. The theory I have read is that they are a bit flummoxed and don’t know how aggressively to move given the impact of all the fancy new facilities they have created. They’d much rather have effective FF to low rather than too high as they try to get a grip on the situation they have created.
The banks are functionally and actually bankrupt and taking the Universe down with them.
It is time to consider nationalizing them. The struggle to pretend they are’nt bk is sucking pressure time as the fuse on the economic bomb they lit burns on.
Millions of going businesses are beginning to sufocate as we fiddle with the crime families.