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Negative interest rates a longshot in U.S., economist Ray Perryman says

The Federal Reserve raised the federal funds rate in December by a quarter percent off near zero for the first time in a nearly a decade, and most analysts believed that mortgage rates would gradually tick up. Since then, however, mortgage rates have fallen to near historic lows, and earlier this month members of Congress pressed Federal Reserve Chair Janet Yellen on whether the central bank would consider going to negative interest rates in a downturn. Economist Ray Perryman, president of Texas-based research firm The Perryman Group, spoke to Scotsman Guide News about the concept of negative interest rates and the most likely course of the Federal Reserve over the next year.

Why have interest rates been falling instead of rising as anticipated?

Ray PerrymanWell, for one thing, the link between a quarter of a point increase in the federal funds rate and the mortgage rate is very tenuous at best. Even if you look at the math and the elasticity and those sorts of things, you would expect very little or no response at all. The factors of supply and demand have more than offset that relatively small effect you would have seen. So, you are ending up in a situation where you are seeing mortgage rates continuing to fall to some extent. The other thing I would point out is that there simply hasn’t been much time yet. Shortly after the Fed’s one small increase in rates, the Chinese stock market failed, some of the U.S. economic indicators were weaker, the Fed started thinking they may slow down their plan to expand interest rates, and the market has all of that factored into the situation as well. So there is not really one factor driving it. There are a lot of different things going on in the market right now.

Earlier this month, a flurry of reports suggested that the Fed would consider going to negative interest rates in the case of another severe downturn? Could you explain what that is?

What it [means] is that the Federal Reserve System, the central bank, would set the rate for banks to pay on deposits at a negative level. In other words, the banks would end up paying for the deposits [or excess funds that the Fed] holds. It has been done in Europe. Right now, it is being done in Japan. Those two areas combined constitute about 25 percent of the world economy. It is something that you have to take seriously. The idea is that it encourages the banks to lend more money because it costs them to hold the reserves. The whole idea is for it to stimulate economies. It also theoretically weakens your currency and that, as a result, makes your exports cheaper and helps stimulate your economy. In practice, in all honesty, it doesn’t seem to be working out that way right now.

And why isn’t it a possibility here?

It is a possibility. I just think it is a very small possibility because there are some downsides to it. You get a lot of resistance from the banks. It cuts into bank profits, which can impact the stock market negatively. Even though you would think it would pull people away from bonds into stocks, that hasn’t necessarily happened. As for the currency effects to stimulate exports, Japan’s currency has actually gone up in value relative to the dollar since it imposed negative interest rates, so that is not necessarily being achieved. It is viewed as a fairly radical response to a very weak economy, the type you are seeing in Europe and in Japan for several years now. We are not really in that situation. We are in a situation where we have seen fairly solid growth for the last couple of years. We have seen some indication of slowdowns in the early indicators this year, but nothing of a huge consequence. The reason that it gets some attention is that since interest rates have been near zero in terms of the federal funds rate for so long, when you are that low, there is no place to go but into negative territory.

Fed Chair Janet Yellen has also said the central bank has no immediate plans to sell off its vast bond holdings. Why is that?

At this point in time, they are just being very cautious. At some point, they are going to have to. The Fed balance sheet is way out of balance. You could argue that it is two or three times the rate it should be for an economy our size. Part of that had to happen during the financial crisis. Part of it continued to happen because the Fed tried to stimulate the economy with the various quantitative easing moves during the very slow point in the recovery. I think [Yellen] is reluctant to pull the trigger in a major way because we are seeing some difficulties in the world economy. Obviously, China is having some major issues right now. There are some issues in Europe. Some of the Middle Eastern countries are suffering significantly with oil prices. We are not seeing signs of inflationary pressure in the United States at all. Commodity prices are low. If [the Fed is] too aggressive in raising rates or selling bonds, they can choke off the recovery.

Do you still think it is still safe to assume that the Fed will raise rates two or three times and mortgage rates will tick up?

That is the most likely scenario  and, by most likely, I would say a 75 percent to 80 percent chance that is what happens. The market has kind of priced that in as its expectation. The Fed really hasn’t done anything to take us away from that expectation other than just saying that they will be very cautious in observing what is going on internationally. It is a reasonable course of action. If something significant were to happen, if the U.S. were to see a major downturn, if a major world event happened, something from a terrorist or unexpected external event happened, you could see them back off that policy.

Do you have any prediction on where the 30-year fixed rate will end the year?

Again, the relationship with mortgage rates and the federal funds rate is tenuous, but it is there. You do see some reaction. Normally, if the federal funds rate went up 1 percent over the course of the year, which seems to be what the market is pricing in right now, you might expect an increase in mortgage rates on the order of 25 basis points, 30 basis points, something like that. So, not a huge move from where we are now, but a modest uptick. 



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