Thomas Barkin, Richmond Fed president has stated loud and clear that he thinks it is not worth it to try negative rates in the US, as he declares that he thinks negative interest rates have been tried in other places, and he hadn’t seen anything that could make him think they’re worth a try in America, adding that if we looked at the recent data, we would see it as low as it would go. Affirming firmly that eventually, people will be brought back to work, and hopefully they will be back to stores, and within weeks or months, he expects this data to go up from where it is.
As we have continuously addressed in previous videos, the idea of taking the economy back from where it was left off it is not a realistic plan at this point in time and history. So it seems that he doesn’t actually have a plan, as this was his response to a dramatic move that echoed across asset classes, in which 2Y yields plummeted to record-lows, while stocks and gold sky-rocketed, making markets finally acknowledge that NIRP is likely to come in the next months. Either way, looking at the Fed funds after Barkin’s statement, we can see that the stock market hasn’t given much attention, with December implied rates still in negative area.
With that said, it seems that the only way out of this mess would be if Powell handled this situation without any delay, reversing the market’s test of the Fed’s resolve from ZIRP to NIRP, however, he has to take action immediately, otherwise if the negative rates become even more accepted, and Powell utterly denies it down the road, making it look like a hawkish reversal, that could potentially lead to another crash in the market, and even with the Fed debating that nobody could have predicted that this was coming, ultimately it will be forced to cut to negative rates anyways.
That’s precisely what BMO analyst, Jon Hill, has been defending, saying that with “certain Fed funds futures contracts now trading with a negative implied yield, Powell needs to decide whether he wants to nip that possibility in the bud – 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.”
In addition, Hill forecasts that “a cut into negative territory remains unlikely. On three separate occasions during the last press conference, Powell referred to the current target range as the ‘effective lower bound’; implicitly acknowledging that any further reduction in the target range would be self-defeating.” But even so, the market doesn’t seem to agree with Powell’s resolution, and investors are currently pushing the negative rates trade for later November.
If Powell neglect to address the situation quickly, over time, more and more proximal Fed funds futures will violate the NIRP lines, to the point that the market becomes sure that NIRP is not only permissible as it is priced in. By that time, it will be terribly late for Powell to intervene, as we could analyze from the latest episodes, once another negative reaction happens in stocks, the Fed’s chair is likely to have a breakdown. If it isn’t in his plans to inject further $2-3 trillion of quantitative equities, because by now, as estimated by Deutsche Bank, that would be proportional to catching down the -1% r* (r-star), his only alternative would be to admit that the US has joined Japan and Europe in the monetary gray area.
As a matter of fact, the Eurodollar market has already started to panic, as many analysts have been saying that with the Fed fund futures climbing to contract highs, it is expected that the first priced negative rate switches from January 2021 to December 2020 tops, setting the next market test of the Fed, with bonds, stocks, and FX pricing negative rates within less than 6 months from now.
Remembering what happened in 2015, when the Fed has started to deal with its first tightening cycle in over a decade, being set to raise rates for the next three years, they were warned that elevating its rates would be a bulky policy error, because, back then, the r* or “the natural rate of interest in an economy where total debt/GDP was 350% and rising, and where GDP was 2% and falling, the short-run equilibrium real interest rate was a paltry 0.57%, which also meant that any attempts to push rates notably higher – as the Fed was doing then – would result in catastrophe forcing the Fed to promptly cut rates, if not go negative,” as stated by a high-profile economy website… Read the full script here: https://www.epiceconomist.com