As interest rates turn negative around the world, the US Federal Reserve is asking banks to consider the possibility of the same happening in the US.
In its annual stress test for this year, the Fed said it would assess the resilience of big banks to a number of possible situations, including one where the rate on the three-month US Treasury bill stays below zero for a prolonged period.
“The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term US Treasury securities,” the central bank said in announcing the stress tests last week.
In that particular simulation, the unemployment rate doubles to 10 percent, the same level it reached in the aftermath of the last financial crisis.
Three-month bill rates have slipped slightly below zero several times in recent years, including in September last year after the Fed delayed rate liftoff amid global financial market turmoil, touching a low of minus-0.05 percent on Oct. 2 last year.
However, in the stress test, banks would have to handle three-month bill rates entering negative territory in the second quarter of this year and then falling to minus-0.5 percent and holding there through the first quarter of 2019.
“This scenario does not represent a forecast of the Federal Reserve,” the central bank said.
It also assumes “that the adjustment to negative short-term rates proceeds with no additional financial market disruptions,” it added.
Fed officials have made clear that they are a long way from contemplating a reduction in rates below zero in their benchmark overnight policy rate. However, some have suggested they would be more open to such a move than in the past should the economy deteriorate significantly.
The central bank left its target range for the federal funds rate unchanged at 0.25 percent to 0.5 percent last week after raising it in December last year for the first time since 2006.
US policymakers chose against pushing rates below zero during the financial crisis partly because of concern it could lead to dangerous dislocations in the money markets.
Since then, the European Central Bank and the central banks of Switzerland, Sweden and Denmark have nudged some official lending rates negative without such repercussions, and Fed officials have publicly taken note.
The Bank of Japan became the latest monetary authority to push rates into negative territory last week in an effort to spur lagging growth and increase too-low inflation.
Former Fed official Roberto Perli cautioned against drawing conclusions about future Fed actions from the inclusion of negative US rates in the stress test scenario.
“It doesn’t signal anything” about future monetary policy, said Perli, now a partner at Cornerstone Macro LLC in Washington.
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