Larry Summers, the former U.S. Treasury Secretary and ex-president of Harvard University, is concerned about the possibility of such a scenario.
“Black hole monetary economics — interest rates stuck at zero with no real prospect of escape — is now the confident market expectation in Europe and Japan, with essentially zero or negative yields over a generation,” Summers wrote in a series of recent tweets ahead of the Kansas City Fed’s annual policy retreat in Jackson Hole, Wyoming. “The United States is only one recession away from joining them.”
Bank of America Merrill Lynch Global Rates Research Strategist Ralf Preusser is also concerned about U.S. interest rates falling to zero amid a global economic slowdown.
“Concerns are rising that by the time decisive action is taken by global central banks and/or on the trade front, in our view it may be too late to push the global economy back on track,” wrote Preusser in a recent report. “Furthermore, U.S. yields in particular may be stuck in a catch-22 between trade rhetoric and central bank action:
- If monetary policy succeeds in supporting growth and equity markets, particularly in the US, then we risk seeing further escalation in the trade war requiring further cuts until rates are at zero (a conventional easing scenario)
- If monetary policy support proves ineffective in supporting the US, then the Fed will be forced to cut further until rates are zero (risking a ”Japanification”scenario for the U.S. curve and the broader DM complex). (DM refers to developed markets.)
Preusser was referring to short-term U.S. rates. The current Fed Funds rate is set in a range between 2% and 2.25% following the Fed’s first rate cut in over 10 years in late July. Market forecasts calls another two or three cuts before end, starting with another 0.25% cut at the Fed’s net meeting in mid-September.
But the minutes from the last Federal Open Market Committee meeting suggest some uncertainty about future Fed rate policy. In addition to the two dissenters at the last FOMC meeting — Boston Fed President Eric Rosengren and Kansas City Fed President Esther George, who opposed any change in rates — there were other participants in the meeting who favored no change in rates and two who preferred a 50-basis point cut.
Attention now has turned to Fed Chairman Jerome Powell, the keynote speaker at the Kansas City Fed’s Jackson Hole, Wyoming, retreat on Friday.
In his speech, Powell noted that the question now for the Fed is how it “can best support maximum employment and price stability in a world with a low neutral interest rate,” meaning a rate that neither stimulates nor restrains growth.
“The current era has been characterized by much lower neutral interest rates, disinflationary pressures, and slower growth … and risks “lengthy, difficult-to-escape periods in which our policy interest rate is pinned near zero.”
Uncertainty about trade policy is weighing on U.S. and global growth but “setting trade policy is the business of Congress and the Administration, not that of the Fed,” said Powell. “There are no recent precedents to guide any policy response to the current situation.”