The market’s pricing for a negative fed funds rate of a few basis points before year-end and extending into 2022 is persisting this morning, and the longer it persists, the more it will be taken as a policy signal by the Federal Reserve that negative rates are a higher up tool on the list of the Fed’s policy options.
** We seriously doubt there has been any change in the Fed’s thinking about the efficacy of negative rates as a viable policy tool from the assertions by Federal Reserve Chairman Jerome Powell, repeated again yesterday by Federal Reserve Bank of Richmond President Tom Barkin, that the Fed strongly believes negative policy rates are unlikely to be an appropriate policy response in the United States. Enormous market structural and political risks loom prohibitively large in the Fed reluctance, and the European experience with negative rates, the health of their banks, hardly offers an alluring policy road map.
** To further blunt any unintended policy signal that negative rates are indeed a near term policy option, we expect Fed officials, either Chairman Powell himself or perhaps Federal Reserve Bank of New York President John Williams, to soon issue a statement or find a virtual forum to reaffirm the Fed’s low priority on negative rates among the policy tools it is reviewing for when it transits from the current liquidity crisis management measures to ensure market function to a revamped monetary policy strategy at the Zero Lower Bound.
** Lifting the Interest on Excess and Required Reserves by 5 basis points would probably go a long way to a technically-driven lift in the fed funds futures pricing back into positive levels, and that an IOER hike was in fact widely expected at last week’s Federal Open Market Committee meeting but not delivered may be one reason the pricing for negative rates has seeped into the market sentiment.
** The Fed still believes its primary policy tools at the ZLB will be built around an aggressive forward guidance and some form of equally aggressive large-scale asset purchases, and that, as needed, 13-3 credit facilities can be extended and expanded by edging further down the credit curve in both purchased assets or the acceptable collateral. In that context, we think the Fed will be running through the gamut of their asset purchase options to practically buying bail bonds, before they seriously weigh going negative on the fed funds target range.
** That said, with every move or utterance scrutinized closely for its signaling intentions, the Fed messaging on negative rates will need to be deftly handled, whether it is in pitching an IOER hike as purely technical rather than a policy tightening, or that negative rates, while not viewed as appropriate for now, can’t necessarily be ruled out forever, for who knows what will be left in the policy tool kit if against all expectations, the economy continues to turn deeply south? The Fed does not want to go negative, and won’t go negative, at least until they have to, but leaving it open even as the remotest of possibilities will be all markets will hear.
** What’s more, our sense is that the Desk and the FOMC are finding useful price discovery information in allowing the market to price rate probabilities further out into this year, and to gauge the market’s capacity to absorb the massive volumes of US Treasury debt issuance slated for the next few months. That the fed funds futures have drifted into negative pricing amid abundant liquidity, and that there was little if any funding stress the day the Treasury announced its larger than expected coupon issuance schedule has probably drawn some careful scrutiny from Fed staff.