If Jerome Powell hoped that he had put to rest the topic - and debate- of negative interest rates in the US (if only for a few weeks) he failed.
One day after Powell's ad hoc appearance in a Peterson Institute video chat in which Powell was very clear: the Fed doesn't support negative rates even with downside economic risks - the question of when, not if, rates will turn negative continues to dominate.
In an attempt to amplify Powell's message, BofA's rates strategist and former NY Fed staffer Mark Cabana writes today that the Fed is rarely this unified in any view: "US negative rates are not an attractive monetary policy tool", adding that Chair Powell was very clear in this view yesterday. It's not just Powell of course, and below the strategist has assembled a summary "of the uniform and widespread opposition to negative rates from a range of Fed officials." The most striking rebuke of negative rates came from the October 2019 FOMC meeting minutes when "all participants judged that negative interest rates currently did not appear to be an attractive monetary policy tool in the United States". It is very unusual to see this type of broad based agreement on any potential policy stance, according to Cabana who adds that in order to see a material change in thinking on negative rates "it would likely require a leadership change and large scale Fed turnover. Neither of these is likely in the near term."
As an alternative to negative rates, Powell has indicated the Fed can ease through forward guidance, UST & agency MBS asset purchases, or "13-3" extraordinary market programs. Indeed, just yesterday we noted that - using Deutsche Bank calculations - to catch down to where the current neutral rate of interest, or r*, is which is at roughly -1%, the Fed would need to conduct roughly $3.3 trillion in QE on top of what the market is currently pricing in.
Cabana expects that, in further distancing itself from NIRP, Fed official will "overweight these tools in support of expansive fiscal policies but not shift their thinking on negative interest rates in the near term."
But far more importantly, Cabana writes that he does not think "the market can "bully" the Fed into adopting negative interest rates." As he explains, while the market can push the Fed to adopt a number of policies, "the case for negative rates is fundamentally different. Negative rates have meaningful implications for the financial system and financial intermediation. If market participants want to position for a Fed that will ease further we would suggest better risk/reward tradeoffs are in lower longer-dated real rates or higher breakevens."
Cabana then makes an extensive list laying out all the various reasons - ranging from legal, to structural, to behavioral - why negative rates are virtually impossible (we will highlight these in a subsequent post) yet what we find fascinating is that despite Powell's solemn admonition and the bevy of reasons why NIRP is likely not on the agenda, the market simply refuses to care, and as Bloomberg notes in an article explaining why negative rates "are the Only Game in Town" for eurodollar option traders, bets that negative rates are coming have soared, as calls that pay off if the Fed sets the low end of the fed funds target range below 0% between September 2020 and June 2021 "have been in steady demand over the past two weeks."
According to Bloomberg's Edward Bolingbroke, the most popular trade expects a rate cut of 10 to 15 basis points by September. That's just the beginning however, because in a clear mockery of Powell's video address, this week demand has picked up for options that offer protection against a policy rate as low as -0.50% by the middle of next year.
At the same time, overnight index swaps are pricing in a rate cut as the Fed’s next move, with no rate increases for at least five years. Per Bloomberg calculations, the April 2021 OIS contract tied to the traded at about -1 basis point Thursday, 6 basis points lower than the effective fed funds rate, "pricing in more than 50% odds of a 10 basis point rate cut."
Meanwhile, the implied January 2021 fed fund rate has continued to dip below 0% even after Powell's speech, although it is well above its Friday crash low, where a -0.4% rate was expected.
The bottom line: far from not "bullying" Powell, the market is just waiting for the next opportunity to pounce on what now seems to be a monetary inevitability: negative rates in the US.
And why not: with the US becoming Japanified with each passing day, it's only a matter of time before Powell imitates every wrong move in the Kuroda playbook, starting with negative rates and concluding with buying equities. All he needs is a catalyst for the next move, a catalyst... like for example the next sharp drop in equities.