On June 10, 2020, the Federal Reserve maintained its target for the federal funds rate—the benchmark for most interest rates—to a range of 0% to 0.25%. The next Fed meeting is on July 28-29 and given the recent economic indicators and the rise in corona virus cases, there is a strong possibility that the Fed may have to cut interest rates once again. But, that would mean we go into an environment of negative interest rates. Negative interest rates are an unconventional economic concept that could turn the world of banking on its head. Federal Reserve Chairman Jerome Powell has repeatedly talked down the idea of below-zero borrowing costs in the U.S. But, he may not have a choice.
Central banks in Europe and Japan have already cut into negative territory, and yields on shorter-term US Treasury bills that mature in one year or less have already dipped below zero. But it comes with fine print: Those policies often come with mixed results and could cause more problems than they solve.
Future Wealth’s View
Negative interest rates operate in an upside-down world of banking. Instead of a bank paying you to park your cash in a savings account, you’ll have to pay them to hold onto your cash. Think of it like a storage fee. And instead of having to pay interest on a loan if you go out and buy a car, you’ll earn a little bit of money with negative rates. If the Fed decided to cut the benchmark borrowing cost, they will then elect to charge banks a fee for parking their reserves in accounts at the Fed. Banks would then pass that policy rate on to consumer products, meaning it will get filtered through to the rest of the economy.
But the impact of negative yields are far from benign. If yields were to turn negative, it’d be unlikely for you to get paid to take out something like a mortgage or an auto loan, and even more so, banks might not want to write out those loans. There’s also a concern that negative yielding consumer products could cause bank runs. People might prefer to keep their money under their mattress, where the interest rate is at least 0 percent.
Given this backdrop, being in equities is a lot safer (if you can believe it) than parking money in a savings account. Is this a twilight zone we are living in or what?