“Powell needs to decide whether he wants to nip that possibility in the bud”, BMO’s Jon Hill and Ben Jeffery wrote Thursday, as fed funds futures presaged negative rates in the US as early as December.
The price action in STIRs made for good headlines – you can’t go wrong with “negative rates are coming to America”, or some bombastic derivation thereof, complete with exclamation points and hyperbole.
This is, in essence, just another manifestation of the “hall of mirrors” effect, wherein the market effectively backs the Fed into a corner, forcing policymakers to either acquiesce, or push back. As money markets priced NIRP (top pane), two-year yields touched record lows (bottom).
It’s always the same story – if the Fed pushes back to reclaim some shred of independence from a market that’s angling to enslave policy, they risk precipitating a hawkish outcome at a decidedly inopportune time.
Assuming the market continues to press the issue by pricing even more dovish outcomes, waiting too long makes the situation worse. “If the FOMC drags their feet too much, they run the risk of creating either a self-fulfilling dynamic and/or having to effectively implement ‘hawkish’ Fedspeak later down the road”, BMO went on to say, adding that in their estimation, it’s still unlikely the Fed will join some of its European counterparts and Japan by cutting rates below zero.
Richmond Fed chief Thomas Barkin seemed to brush the market aside Thursday during remarks to CNBC. “I think negative interest rates have been tried in other places, and I haven’t seen anything personally that makes me think they’re worth a try here”, he said.
Barclays’ Michael Gapen stated the obvious, telling Bloomberg that record lows for two- and five-year yields as well as STIRs pricing negative rates is a reflection of deflation risk. “We’re flirting with the idea and do see substantial risks around our base-case view”, he said, referring to a possible deflationary spiral stateside.
“We risk a lot of small businesses having to close permanently, leaving the unemployment rate elevated for an extended period of time”, Gapen went on to caution, adding that “if businesses close and there’s no one there to turn lights on as states re-open, labor market slack can get baked into lower inflation and inflation expectations”.
This is precisely what Goldman wrote earlier this week in explaining why the bank isn’t particularly concerned about inflationary outcomes despite the ostensibly combustible policy mix.
“As the global economy recovers, we are likely to hear louder voices warning that a failure to normalize monetary and fiscal policy risks much higher inflation or even currency debasement, so it is probably worth noting preemptively that we do not share these concerns”, Goldman’s Jan Hatzius wrote, in a May 4 note.
He went on to remind you that “much of the unprecedented easing of fiscal policy is effectively bridge financing that will automatically unwind when it is no longer needed [and] even under a reasonably optimistic growth forecast, it will take several years to put people back to work and fill empty offices and storefronts”.
You’re reminded that the Fed refrained from tweaking IOER at the April meeting. TD said Thursday that in the event effective fed funds falls below 2-3bps, RRP and IOER will need to be raised. The bank says “negative rates implied by futures should not force any Fed action” and the move in STIRs “isn’t justified by fundamentals”.
They expect some pushback in upcoming Fedspeak, noting that policymakers “have repeatedly stated that they do not expect to take rates negative”.
That’s true, but here again we come back to the same issue, which is that, as Bloomberg’s Cameron Crise put it on Thursday, “for the last 18 months or so the Fed has behaved like a puppet at the end of STIR traders’ string”.
Of course, if the Fed does want to “go there”, so to speak, there’s ample justification, depending on your definition of “justification”. The dollar has remained stubbornly resilient, and relentless pressure on commodity prices isn’t doing breakevens any favors. This harkens back to a discussion Deutsche Bank’s Stuart Sparks has been having at least since last summer. Readers may recognize the following excerpt from Sparks, as it appeared here late last month:
March presented a painful but instructive lesson on the potential risks of abrupt significant increases in real yields or the real term premium, such as might reasonably be expected if effective real short rates remained significantly higher than r*, the Fed tapered balance sheet growth prematurely, and the Treasury was left to fund fiscal stimulus absent Fed demand. At the outset of the oil price war, the meltdown in breakevens caused real yields to spike and the broad dollar to hit its strongest levels in 17 years. This dynamic illustrated local circularity, as falling commodities further pressured commodity prices and breakevens, driving real yields higher. We expect the Fed to continue to depress the real term premium to maximize incentives for capital to be allocated into funding for the non-financial corporate sector and to minimize further dollar appreciation which threatens already weak commodities and shaky inflation expectations.
In the absence of actually cutting rates into negative territory, engineering the equivalent of a negative policy rate will need to be achieved via trillions in asset purchases, which is Deutsche’s expectation.
But if the price action on Thursday is any indication, the market is prepared to push the envelope – up to and until the Fed pushes back. Waiting too long could leave the Fed in the extremely uncomfortable position of having to catch the market offsides, with the result being a sudden tightening of financial conditions. That’s the trap embedded in the “hall of mirrors” dynamic.
Finance-focused social media (and by that, I mean the sometimes hellish world that is “finance Twitter”) was ablaze with negative rates banter Thursday. Even Carl Quintanilla got in on the act.
I’ll leave you with a smattering of what you’re missing by refusing to tune in to the daily cacophony which, while technically silent, is sometimes as deafening as the loudest sirens.
Weeeeeeehooooo! The June 21 Fed Funds Future is now pricing an implied risk of negative Fed Funds rates!
— AndreasStenoLarsen (@AndreasSteno) May 7, 2020
Fed funds futures have broken out. Trading above 100. Implies negative US rates. (not investment advice): pic.twitter.com/WhOu6VxUqp
— Nick Reece, CFA (@nicholastreece) May 7, 2020
April 2021 fed funds future printed above par
*eyes emoji* pic.twitter.com/2zyTTGeZO4
— Luke Kawa (@LJKawa) May 7, 2020
holy crap ….. Fed Funds futures pricing in negative Fed Funds in 2021 ….. any number above 100 = negative Fed Funds pic.twitter.com/Y60J1ENuGS
— Gin Lane Securities (@GinSecurities) May 7, 2020
A quiet capitulation is happening in the Fed funds futures market – all futures contracts beyond November 2020 are pricing in negative rates despite a lack of Fed guidance on this pivot. 30-year Treasury bond erased all of yesterday's losses pic.twitter.com/uaM8Yix4K3
— Victor Xing (@TheKekseliasWay) May 7, 2020
Powell/Clarida/Williams are going to need to hammer home this point for fed funds futures to buy it
— Brian Chappatta (@BChappatta) May 7, 2020
Uhhh, Fed funds futures.
(via DRW) pic.twitter.com/zEeVV1xzKA
— Carl Quintanilla (@carlquintanilla) May 7, 2020