There is every reason to believe that the longest bull market in U.S. history will be slowing down. Economic cycles are normal. Even though jobs continue to be plentiful, employers are scrambling to fill positions, and wages are excellent, the recent economy boon is already waning.
The question is, will the U.S. be heading toward a recession in 2020? If so, will the Federal Reserve revert back to the tactics it used following the 2008 financial crisis and lower interest rates or even establish negative interest rates?
As the U.S. continues to engage in a trade war with China and plunging global oil prices, investors are anticipating a recession.
The Federal Reserve does not have a good track record for dealing with recessions. While it has raised interest rates four times in a year, it held interest rates at zero level or even below following the last recession. It has already pulled back from one anticipated rate increase in 2019. It may even pivot its stance on these remaining rate increases. In the past, the Federal Reserve has been known to cut interest rates up to five percentage points. With interest rates wavering around 2.5 percent, there is a limit to how much the Federal Reserve will be able to slash its rates this time around.
The Fed was resistant to implementing negative interest rates during the 2008 financial crisis. This time around, it may be more willing. Interest rates are the cost of borrowing. For example, if you borrow $1,000 at a 2 percent interest rate, you will end up paying the bank $1,020. That is how banks make their money. If said interest rate were to be -1 percent, the bank would have to pay the borrower $10 just for taking out a loan. This is not good business practice. Why would banks even consider it?
Central banks have been known to use negative interest rates as a means to stimulate a stagnant economy and to encourage borrowing. It’s a practice started by Sweden’s central bank when it slashed its overnight deposit rate in 2009 to -0.25 percent. Other central banks followed suit with a resultant $9.5 trillion of debt having a negative yield.
Negative interest rates are a desperate policy of last-resort to encourage borrowing and business and consumer spending. During an economic slowdown, people spend less money. This, of course, weakens the economy even further as prices and unemployment rise. So, banks encourage more borrowing and higher levels of spending. The policy of negative interest, however, can easily backfire as banks simply find it too unprofitable to lend money. Paying people and businesses to borrow and penalizing savers is a self-defeating practice.
Lowering interest rates in the mainstay of a policy called quantitative easing. With quantitative easing, the Federal Reserve invests in government securities in an effort to keep interest rates artificially low and to increase the supply of available money to making borrowing easier. However, this policy of free money can easily lead to inflation. It devalues the currency and makes imports more expensive.
If the Federal Reserve returns to utilizing negative interest rates as an economic stimulus, consumers would in effect pay for the privilege of keeping their money in a bank. Whether people will remove their funds from their banks and risk being robbed is unclear. The choice is between stashing money beneath a mattress or paying a small fee to maintain a bank account. Most individuals and businesses do require some type of banking facility.
Globally, interest rates have never been lower. If the Federal Reserve embraces a negative interest rate, the ripple effect will be felt worldwide as advanced and third world economies risk greater economic slowdown and lower profits.