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Coronavirus, Economy, Rate Cuts & Negative Interest Rates

Coronavirus Fears & Wall Street Woes!

The Coronavirus is spreading fear throughout the economy with Markets tumbling more than 1,000 points in consecutive days. This is giving people real concern and pause. All of this coming after the CDC’s warning and with President Trump addressing the nation regarding this matter.  

When market volatility & uncertainty arises, the Federal Reserve comes into play. The Fed meets in March likely there are more rate cuts planned due to uncertainty of the coronavirus. The speculation & fear spreading about the economic impacts of workplace & school shutdowns, cancelled events and the rippling effects the virus could cause in the long term, are giving rise to the market volatility. The Fed meets again in March of 2020 and rumors are abound they will cut rates anywhere from .25% to half a point.

The Federal Reserve is in charge of monetary policy, but many people do not know what that means. Read an excerpt from fas.org to put it all in normal perspective terms.

Congress has delegated responsibility for monetary policy to the Federal Reserve (the Fed), the nation’s central bank, but retains oversight responsibilities for ensuring that the Fed is adhering to its statutory mandate of “maximum employment, stable prices, and moderate long-term interest rates.”

To meet its stability mandate, the Fed has set a longer-run goal of 2% inflation. The Fed’s control over monetary policy stems from its exclusive ability to alter the money supply and credit conditions more broadly. Normally, the Fed conducts monetary policy by setting a target for the federal funds rate, the rate at which banks borrow and lend reserves on an overnight basis. Beginning in 2007, the federal funds target was reduced from 5.25% to a range of 0% to 0.25% in December 2008, which economists call the zero lower bound. By historical standards, rates were kept unusually low for an unusually long time to mitigate the effects of the 2007-2009 financial crisis and its aftermath. Starting in December 2015, the Fed began raising interest rates. In total, the Fed raised rates nine times between 2015 and 2018, by 0.25 percentage points each time. In light of increased economic uncertainty, the Fed then reduced interest rates by 0.25 percentage points in a series of steps beginning in July 2019.”

However, the US Monetary policy also dictates that there is a “zero lower bound” on how much the economy can be stimulated in this way.

In basic English, The Feds job is to keep our financial economy stable and strong. They stimulate the economy in times of economic hardship, or decline, in booming and robust markets, they keep inflation at bay and ensure we don’t grow too fast or become unstable.

How does the lowering of the Fed Rate stimulate the economy or help you?

Influencing interest rates is an important piece of monetary policy. If the economy is slowing, then the conventional response is to lower interest rates, which in turn has two primary effects:

  • Consumption and investment spending increase because the cost of borrowing is lower.
  • People saving their money in “safe” places (like deposits at a bank) earn a lower rate of interest and are incentivized to either save less or invest their money in riskier assets that offer higher expected returns. Both of these options would again spur consumption and investment.

The cost of borrowing to the consumer is lower in the following ways:

  1. Credit Cards
    • Credit Cards are based off of the prime rate, which is the rate banks extend to their customers based on credit. Typically, it runs about 3 percent higher than the Fed Funds Rate.
    • A rate cut in the Fed Funds Rate, the Prime Rate will lower too, and credit cards will likely follow suit.
    • As a result, card holders could see lower APR (annual percentage rate) over the next 2-3 billing cycles. This reduction saves you on the interest paid.
  2. Savings Accounts
    • The APR banks pay customers for keeping their funds deposited will decline to a lower threshold, so the days of 2.50% interest on your money may go down to .10%. You may lose interest on the savings side.
  3. Auto Loans
    • Purchasing a NEW car? It may not have a big impact on what you pay, auto rates have stayed low even after rate hikes instead of rate decrease.  Often times new cars can offer a 0% interest rate.
    • Planning on purchasing a USED car? This may have a small impact on what you pay, since used cars can come with a higher interest rate, you may see a small tick down on what you pay. Estimated savings are small but could be anywhere from $3-$7 dollars depending on the amount of the rate cut.
  4. Student Loans
    • While many consumers have fixed rates on their student loans, some people have private loans which can come with a variable rate. Based off the prime rate, which means with a rate cut, those variable rates will decrease some, which will result in less interest being paid.
  5. Mortgages
    • Mortgages are not tied to the Fed Funds Rate. The mortgage rates are tied to yields on the US Treasury Notes (10 Year). The overall economy & inflation all sway the rate on fixed mortgage rates. “Mortgage rates this low at the end of an economic cycle is nearly unprecedented, and may be very well keeping the housing market — and U.S. economy — afloat,” said Ralph McLaughlin, deputy chief economist and executive of research and insights for CoreLogic.

All of the ways The Fed can stimulate the economy is capped by the position to not go below the Zero Lower Bound. In other words, nominal interest rates cannot go below zero. Otherwise, borrowers would get paid to borrow money! Many countries have a negative interest rate policy and President Donald Trump has suggested this monetary policy for the US in the past. Meanwhile, many financial experts say this would not end well. The Fed has not followed a negative interest rate policy, does not appear to want to take the US in this direction. Fed Chair Jerome Powell has stated that a forward guidance policy and large-scale asset purchases is preferred method.  They considered it during the Financial Crisis but do not anticipate revisiting this tool.

What would Negative Rates Look Like?

Under a negative rate policy, banks and other financial institutions have to pay interest for parking excess reserves with the central bank. It’s a way to encourage banks to lend to businesses and consumers, who don’t get paid to borrow, 

Negative interest rate policies suggest this idea is not as crazy as it sounds and it is true interest rates can indeed go below zero. With a negative interest rate, the central bank is essentially telling private banks “use it or lose it. The interest rate we are talking about is the rate banks will be paid on their excess reserves at the central bank, think of it as the funds banks are not using anywhere else.

Negative interest rates have served as an effective policy tool for countries that have implemented them, at least in terms of easing financial conditions, according to a Federal Reserve study.

Would Consumers Receive Interest to Borrow?

Not necessarily! It could mean that loans to individual consumers would receive a negative interest rate, but probably not. All banks have to do to avoid charges from the central bank is use the money they would have held in excess elsewhere.

 Banks will be able to draw in businesses and borrowers for these new funds if they lower their interest rates. Even though negative rates for banks do not always translate into negative rates for borrowers, they do creat lower interest rates for borrowers than what is possible now, at the “zero lower bound.”

Consequences of Negative Interest Rates

It is a rather new monetary policy tool, and not one currently employed by The Federal Reserve, although was considered during the Financial Crisis of 2007-2009. Negative Rates are divisive due to both their known and unknown conceivable effects.

If you assume 100% that negative deposit interest rates result in lower interest rates to households and businesses, your knee jerk reaction may be that this is a generally a favorable policy. Yet, people will be impacted by rate cuts in a variety of ways.

For example, if negative interest rates influenced mortgage rates, expenditures on housing might increase. We must not fail to remember the lessons from our past.  The easy access to mortgage borrowing contributed to a massive build-up of values and consequentially a steep fall in home values.

Consumers in retirement or preparing to enter retirement tend to prefer safer more stable investments, and, a negative interest rate plan makes safe investments much less appealing, subsequently resulting in moving no longer attractive investments toward riskier investments – which can result in fortunes and retirement declining rapidly.

For businesses and would be businesses, the fundamental idea is that businesses will take full advantage of this occasion and increase investing & spending if interest rates are lower. A basic principle is that the existing allotment of resources can be made much more efficient, and this may or may not be accurate.

Research Says:

In a recent research paper, San Francisco Fed economist Jens H.E. Christensen looked at the results of five foreign central banks that implemented subzero rates starting in 2012, when the Danish National Bank first went negative. In each case, the move immediately brought government rates down and helped loosen up those economies.

Had the U.S. done the same, Christensen wrote, its growth rate after the financial crisis might have been better. The U.S. Federal Reserve took its benchmark rate down to a target range of zero to 0.25% at one point, but never crossed the threshold to go negative.

“Evidence that the U.S. post-crisis economic recovery was constrained by this policy choice … suggests that mildly negative U.S. policy rates from 2009 to 2011 could have supported higher economic growth and eventually pushed up inflation closer to the Federal Reserve’s target,” he said.

What We Should Take Away?

You might have heard that the fear of a new virus from China is spreading faster than the actual virus.

The stock market’s steep drops this week reflect fears among the general population and investors alike, on future productivity, long term global impacts and the potential for very harsh measures that may be undertaken to prevent the spread of the virus, including quarantine. The virus, along with threats of quarantine, are part of what is spreading fear for many; take the Diamond Princess cruise ship. Passengers have been voicing their concern about their wait on the ship, including by flying banners calling for help from the ship’s balconies.

From earnest officials trying to calm a building panic. From your spouse. From the know-it-all who rattles off the many much more likely ways you’re going to die: smoking, car accidents, the flu.

Sincere public representatives attempting to put at ease a population growing with panic. From your spouse, kids, From the know-it-all who rattles off the more likely ways you’re going to die: smoking, car accidents, the flu.

Yet, none of it seems to matter.

As the number of new cases rise — more than 76,000 and counting — fear is advancing comparable a tsunami. And not just in the areas surrounding the Chinese city of Wuhan, or the sites with the vast majority of coronavirus infections. Fear, spread by word of mouth and more rapidly, through social media is real. Fear and speculation can do more harm than good.  

With news of rising death tolls and crashing stock markets, and declarations from top officials that the US is unprepared to handle the pending global pandemic, it’s unsurprising that Americans are worried, if not downright panicked, about the coronavirus.

According to psychologists, coronavirus-related anxiety is an understandable response to the unknown, but some people are especially vulnerable.

The fear and speculation can cause a lot of harm, mental anguish, anxiety, stress and worry.  The same is true of epidemics and the economy.

To cope, they recommend limiting media exposure to the topic by sticking to one or two trusted sources.

The unknown is more likely to spark fear than the known

According to psychologist Baruch Fischhoff, a professor at Carnegie Mellon University and expert in public perception of risk, it’s natural to fear the unknown, which the flu, of course, is not.

“With coronavirus, we don’t know where it’s going,” he said in a special episode of the American Psychological Association’s “Speaking of Psychology” podcast.

Because panic arises when people overestimate a threat and underestimate their coping abilities, “watching coverage that repeatedly emphasises both the rapid spread of coronavirus and lack of effective treatment” is a fuel for the anxiety fire, Pike said.

“The best thing we can do is make sure to wash our hands, and protect ourselves as we would with any other virus,” she said, like by also avoiding people who seem sick.

Sources

Anneken Tappe | Federal Rate Cute Expected

Anna Medaris Miller, Business Insider | Science Alert – Feeling Anxious Over The Coronavirus?

Federal Reserve Bank of St. Louis | Research Paper Subzero Rates

Don Schlagenhauf, Economist, and Ryan Mather, Research Associate | Primer Negative – Interest Rates

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