Negative interest rates in the US were once taboo. The C-19 coronavirus chaos changed that, and has forced investors to give serious thought to the implications of such a drastic policy shift.
Rate options, which gauge monetary policy expectations, Monday implied a 23% probability that the Key federal funds rate will go below Zero by the end of December, according to BofA Securities data, which cited short expiry options on 1-yr US swap rates. That compares with a 9%-10% probability last week.
Fed funds futures are pricing in rates of about 1 bpt below Zero by June 2021 as the medical malpractice hammers the US economy toward its steepest downturn since the Great Depression.
Negative interest has gone from theoretical to distinctly possible
Most Fed watchers think the Fed is far away from going negative. Yet the unprecedented price moves show a market bracing for the unthinkable, and investors preparing for consequences ranging from a bank profit squeeze to sub-Zero bond yields, money market turmoil and capital outflows.
Bond investors see a chance that bond buying from the Fed pushes benchmark US yields to uncharted negative territory. A projection shows benchmark 10-yr yields hitting -0.5% at the end of Y 2021.
Ultra-low rates drive demand for bonds, since their higher coupon becomes more attractive.
That in turn compresses yields, a factor that has driven up gold prices, since the precious Yellow metal becomes more attractive relative to bonds. Gold is up around 12% YTD.
Investors worry that the United States crossing the Zero bound may have bigger disruptive side effects in money markets than the yrs of negative rates in Europe and Japan.
Have a healthy day, Keep the Faith!