Fed Funds Rate Headed to Zero, JPMorgan Says

JP Morgan Chase & Co. (JPM) economists weighed in late Wednesday on the federal funds rate, predicting a two half-point cut by the end of January, bringing the federal funds rate to zero percent by early next year — a zero percent rate policy (or ZIRP) the JPM economists expect to hold fast through 2009. JP Morgan previously forecasted the central bank to cut rates by a quarter-point in December, bringing the benchmark rate to .75 percent. “The change in our call is motivated in large part by the risk that deflation becomes more likely in an environment where labor market slack is building, and ongoing financial tightening is delaying the prospect that slack begins to get worked down,” wrote Michael Feroli, U.S. economist for JP Morgan. The economists said that taking the target rate to zero percent would not be costless for the Fed. Public perception that the fed has “run out of ammo” may further damage public confidence, but Feroli said he doesn’t believe going to ZIRP implies that the Fed cannot do more. “We would expect the Fed’s leadership to communicate that even a central bank operating at ZIRP still has many tools at its disposal,” he wrote. An increasing number of Fed speakers have expressed the view that the recent increase in the Fed’s balance sheet constitutes quantitative easing, or QE — a monetary policy to fight deflation — which might naturally follow ZIRP. “Normally, one would expect ZIRP to precede quantitative easing, but because of the flexibility created by interest on reserves,” explained the economists, “in the current case QE can actually precede ZIRP.” Which seems par for the course in the current crisis, really: take everything you thought you knew about monetary policy and throw it onto its head. Write to Kelly Curran at Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

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