The Fed has all but ruled out (meaning not) the economic and financial-markets impact of the C-19 coronavirus chaos that is causing investors to give serious thought to the implications of a policy shift to negative interest rates
Rate options, which gauge monetary policy expectations Monday implied a 23% probability that the Key fed funds rate will go below Zero by the end of December 2020, 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 1bpt below Zero by June 2021 as the C-19 coronavirus chaos hammers the US economy into its steepest downturn since the Great Depression.
“It has gone from theoretical to distinctly possible”
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.
We see the chance that bond buying by the Fed pushes benchmark US yields to negative territory.
A projection on Guggenheim Partners’ website shows benchmark 10-yr yields hitting -0.5% at the end of Y 2021.
Investors worry that the US crossing the Zero (ZIRP) band may have bigger disruptive side effects in money markets than the yrs of negative rates in the EU and Japan. As, in the United States, companies rely on credit markets for their financing, adopting negative rates in the US would disrupt the pricing of many securities.
The lower band of the Fed’s benchmark rate is already Zero. Negative rates are viewed as an emergency measure for driving growth even more.
Yet, because years of such policies in Europe and Japan have failed to provide any help, there is plenty of skepticism that the US will follow suit.
Fed Chairman Powell said in March that negative rates would be unlikely to help the economy. Investors expect him to reinforce that message during webcast comments scheduled Wednesday.
Political blowback from a move that would hurt savers, in a country where saving is part of the national makeup, would also be difficult to navigate, as would harm to the financial sector which depends on interest rate margins for income from loans.
The economic damage caused by the C-19 coronavirus chaos has forced the Fed to roll out an unprecedented range of programs, including expanding its corporate bond-buying to include some speculative-grade debt, aka junk.
That policy redistributes income from those who have benefited from many years of lending to those who need to borrow. In that sense, they are similar to various income and rent support programs for those who have been hit by the lockdowns.
Ultra-low interest rates drive demand for bonds, since their higher coupon becomes more attractive.
That compresses yields, a factor that has pushed up gold prices, since the precious Yellow metal becomes more attractive relative to bonds. Gold is up about 12% YTD.
In stocks, the consequences are less clear because of the extreme level of uncertainty around current and future company earnings.
Negative rates could accelerate a rotation away from under-pressure financials into pharmaceuticals, utilities and telecoms, where dividends tend to be higher.
Beyond that, negative rates could drive money out of the US as investors seek higher yields abroad, said the Asia-Pacific CIO for fixed income at HSBC Global Asset Management in Hong Kong.
Have a healthy day, Keep the Faith!
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