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NEW YORK: Negative interest rates in the United States were once unimaginable. The coronavirus has changed that.
Although the Federal Reserve has almost ruled it out, the widespread impact of the pandemic on the economic and financial markets has forced investors to think seriously about the implications of such a drastic policy change.
Rate options, which measure monetary policy expectations, on Monday implied a 23 percent chance that the key federal funds rate would drop below zero in late December, according to data from BofA Securities, who cited short-term maturity options on a one-year exchange in the US. USA rates. That compares to a 9 percent to 10 percent probability last week.
Federal Reserve fund futures are trading at rates of about one basis point below zero for June 2021 as the pandemic pushes the U.S. economy into its worst recession since the Great Depression.
“It went from theoretical to clearly possible,” said Michael Purves, chief executive of Tallbacken Capital Advisors.
He still thinks the Federal Reserve is “so far” from being really negative. However, unprecedented price movements show a market readiness for the unthinkable, and investors are preparing for consequences ranging from declining bank earnings to below-zero bond yields, money market turmoil, and capital outflows.
Scott Minerd, global chief investment officer at Guggenheim Partners, sees the possibility that buying the Fed bonds will push benchmark US returns. USA To unexplored negative territory.
A projection on the Guggenheim Partners website shows that 10-year benchmark returns reached -0.5 percent in late 2021.
Investors fear that the United States crossing the zero limit may have more damaging side effects on the money markets than years of negative rates in Europe and Japan.
“Adopting negative rates in the United States would cause more disruptions than in Japan or Europe,” said Ayako Sera, market strategist at Sumitomo Mitsui Trust Bank in Tokyo.
“In the United States, companies rely on credit markets for financing … adopting negative rates in the United States would alter the price of so many securities.”
POWELL PUNT
The lower limit of the Fed benchmark rate is already zero. Negative rates are generally considered an emergency measure to further stimulate growth.
However, because years of such policies in Europe and Japan have failed to provide a panacea, there is great skepticism that the United States will do the same.
Fed President Jerome Powell said in March that negative rates would be unlikely to help the economy. Investors hope it will reinforce that message during comments on the webcast slated for Wednesday.
The political reversal of a measure that would harm savers, in a country where saving is part of the national psyche, would also be difficult to navigate, since it would harm the financial sector that depends on interest rate margins for the income of the loans.
Still, the economic damage caused by the coronavirus pandemic has already forced the Fed to implement an unprecedented range of programs, including expanding the purchase of corporate bonds to include speculative-grade debt.
“Negative rates are possible,” said Akira Takei, fund manager at Asset Management One, which is long-term bullish on US Treasuries. USA And betting on the yield on 10-year US bonds could drop to zero.
The policy effectively redistributes the income of those who have benefited from many years of loans to those who need loans, he said. “In that sense, they are similar to various income and rental support programs for those who have been affected by the blockades.”
HOT BONDS, MAY NOT BE STOCKS
Ultra-low rates drive bond demand, as your higher coupon becomes more attractive.
That in turn compresses yields, a factor that has already raised gold prices as the metal becomes more attractive relative to bonds. Gold rose about 12 percent this year.
Beyond that, negative rates could take money out of the US. As investors seek higher returns abroad, said Cecilia Chan, Asia-Pacific fixed income investment director at HSBC Global Asset Management in Hong Kong.
“I don’t expect negative rates to continue in the United States,” he said. “(But) I think the impact on Asian credit would probably be positive. Asian bonds offer a decent yield recovery against deposit rates.”
In equities, the consequences are less clear due to the extreme level of uncertainty about the company’s current and future earnings.
Negative rates could accelerate the turnover of financial companies under pressure to pharmaceuticals, utilities and telecommunications, where dividends tend to be higher, said John Praveen, portfolio manager for QMA, the quantitative solutions business Global and multi-asset PGIM.
He believes, however, that rates are unlikely to drop below zero anytime soon, and if they did, it would be a bad sign.
“If the Federal Reserve decides to turn negative, it is a sign that they have run out of ammunition. Clearly, that is not the case.”
