Fed chief Yellen: We do have the legal basis to pursue negative rates

Posted on

Ben Bernanke, the Federal Reserve chairman during the lead-up to the subprime housing implosion and subsequent financial crisis, infamously never saw any of it coming.

For example, to recall just a couple of his bloopers, in February 2006 he predicted that house prices will probably continue to rise, while in May 2007 he declared, We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.

Fast-forward to Tuesday, June 21, 2016, and current Chairwoman Janet Yellen took the hot seat before a Senate banking panel to assert that she doesn-t see a recession coming in the U.S., even if the United Kingdom votes to exit the European Union in its June 23 Brexit referendum. I think the odds of a recession are low. It is certainly not what I am expecting, she said.

Recession is already here, expert says: However, she had to admit in her prepared testimony that considerable uncertainty about the economic outlook remains. And numerous analysts think the risks are to the downside.

The U.S. most likely entered into a recession at the end of last quarter, Michael Pento of Pento Portfolio Strategies recently argued. That’s right; when adjusting nominal GDP growth for core consumer price inflation for the average of the past two quarters, the recession is already here.

Of course, Yellen is the same Fed chief who was forecasting four interest rate increases for this year after hiking the federal funds rate just 25 basis points in December for the first tightening in almost a decade.

Is this Yellen’s Bernanke moment?: Yellen also dismissed the dangers of the Feds ongoing low-rate policy in inflating asset bubbles. I would not at this time say that the threats from low rates to financial stability are elevated. I do not think they are elevated at this time. But of course it is something that we need to watch because it can have that impact, she said.

Instead of the hawkish notes she was sounding just months ago, Yellen continued to stress the message of ongoing easy-money policies. Proceeding cautiously in raising the federal funds rate will allow us to keep the monetary support to economic growth in place while we assess whether growth is returning to a moderate pace, whether the labor market will strengthen further, and whether inflation will continue to make progress toward our 2% objective, she said.

Significant shortcomings in negative rates: But the most interesting assertion Yellen made Tuesday was that the Fed, in her opinion, has the legal authority to impose negative interest rates if economic conditions warrant them.

I believe we do have the legal basis to pursue negative rates, but I want to emphasize it is not something that we are considering, she said. This is not a matter that we are actively looking at, considering when we’ve looked at that in the past we have identified significant shortcomings of that type of approach. We don’t think we are going to have to provide accommodation and if we do, that’s not something that’s on our list.

Given the Feds abysmal track record at forecasting U.S. growth rates and even its own rate-hiking path, the message here is to be very afraid. Why? Because after numerous about-faces and failed follow-throughs, most recently personified by St. Louis branch President James Bullard’s full-tilt dovish conversion, the Fed has now lost all credibility.

If Yellen is asserting that the Fed doesn’t anticipate more accommodation and that negatives rates are not its weapon of choice, then investors should have learned by now that, in all likelihood, sooner rather than later, well be looking at a more accommodative central bank that will have no choice but to follow its central-bank peers in rolling out negative rates. The time to prepare your portfolios is now.