Central Banks

US rates head towards zero. What then?

US gold coin

A new version of quantitative easing is coming as the Fed considers all its options.

After the Fed’s 50bp interest rate cut on 3 March, further monetary easing is on the cards in the US as market and financial conditions continue to tighten. We now expect further Fed easing on or before the Federal Open Market Committee’s next meeting on 18 March. Most likely, we will see another large 50bp rate cut, broadly in line with current market expectations.

 

In other words, the Fed is likely to bring rates down to the ‘zero lower bound’ (ZLB) soon. Furthermore, the Fed will likely engage in ‘quantitative easing (QE) 4.2’ in April—or by June at the very latest, when hard data will show the extent of the economic damage caused by the virus and by the sharp drop in oil prices, which is undermining the US shale oil boom (oil prices of below USD50 are a net negative for the US economy). One could argue the Fed already resumed QE in October 2019 (‘QE 4.1’) when it stepped in to purchase T-bills, officially to stem the draining of liquidity from the banking system.

 

We do not see much appetite in Congress for re-opening discussions to allow the Fed to broaden its asset acquisitions to, say, equities as some other central banks are allowed to do. Revisiting the Federal Reserve Act risks opening a Pandora’s Box and would represent a move towards Modern Monetary Theory. The Fed would risk losing its political independence in the process.

 

There is an off-chance that the Fed is empowered to buy oil via the securitisation of the US’s strategic petroleum oil reserve. Boosting oil prices would help both shale oil producers and the US economy at large. Crucially, it would help re-anchor inflation at 2%. But at this stage we think such a move is a very long shot.

 

Our ‘big picture’ view is that the Fed is in a ‘debt dominance’ monetary regime, obliged to keep policy loose by the high level of federal and government debt. The rapidity of the Fed’s response to coronavirus-related market stress and the likelihood that the Fed will revert to the zero lower bound in the coming weeks vindicates this view. Monetary policy normalisation, i.e. a return to pre-financial crisis rates of interest in a context of classical ‘inflation targeting’, looks all but impossible now.

 

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