Fed Study Highlights Significant Medium-Term Risk of Return to Zero Rates

Recent analyses from the New York and San Francisco Federal Reserve Banks highlight a significant risk that U.S. interest rates could return to near-zero levels over the medium to long term, despite currently elevated interest rates. Market data suggests about a 9% probability that the federal funds rate will hit the zero lower bound (ZLB) within the next seven years, with heightened uncertainty around the economic outlook increasing this risk. Historically, the federal funds rate hit the ZLB during the Great Recession and again at the start of the COVID-19 pandemic, prompting unconventional monetary policy measures such as bond-buying programs and expanded communication strategies. While expected future interest rates are comparatively high now, the uncertainty index is nearly double what it was in 2018, making the possibility of returning to zero rates similar to levels seen before the 2019 rate cuts. This dynamic poses challenges for monetary policy, as lower bounds limit the Fed's conventional stimulus tools, requiring alternative approaches to support the economy during downturns. Overall, the risk of returning to zero interest rates remains a critical consideration for policymakers amidst ongoing economic uncertainty.