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IS THE US HEADED FOR NEGATIVE RATES?


In the search for higher economic growth and a desire to create some inflationary pressure, in the last several years the European Central Bank (ECB) and the Bank of Japan (BoJ) have pushed their short-term policy rates into negative territory. If the US were to enter a recession, what would the Federal Reserve (Fed) do? Would the Fed follow the lead of the ECB and BoJ into negative rate territory?


First, let’s be clear that a US recession is not our base case. We put the recession probability for 2020 at only around one-third. The US is, however, in the longest economic expansion on record, and business cycle theorists worry that all good things must eventually come to an end. Our perspective is that economic expansions are dynamic processes that do not end due to old age. If one only looks through a rear view mirror, then it appears that there might be predictable economic cycles, but that would be an illusion. Looking forward, something has to cause a recession, and it is usually related to too much debt in one or another sector of the economy, such as mortgage debt in 2007-2008 or high yield debt in 1990-1992. So, when an over-indebted sector can no longer service its debts, there is the possibility of an economy spiraling into recession. While debt levels are on the rise, it is not our view that they are so high that the trade war or some other cause would tilt the US into recession in 2020.


Yet, eventually, the US economy may experience another recession, and so the question we are analyzing here is how would the Fed react, and specifically would the Fed adopt a negative rates policy as some other major central banks have done. Our short answer is “no”; the Fed is unlikely to adopt a negative rate policy. The analysis is a bit more complicated.


22 | ADMISI - The Ghost In The Machine | November/December 2019


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