Treasury Bond Rally Sparks Bets on Negative U.S. Interest Rates

Benchmark 10-year bonds yields tumbled to a fresh all-time low Friday, raising the spectre of negative interest rates in the world's largest economy.
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U.S. Treasury bond yields plunged to a fresh record low Friday while bets on future cuts from the Federal Reserve intensified, raising the prospect of negative interest in the world's biggest economy.

Benchmark 10-year Treasury note yields tumbled to an all-time low of 0.699% in early Friday trading, just three days after breaching 1% for the first time ever following the Federal Reserve's emergency 50 basis point interest rate cut earlier this week.

The move pull 30-year bond yields sharply lower, and on pace for the biggest single-day decline since 2011, to trade at 1.349% shortly after. 

CME Group futures prices, meanwhile, suggest even deeper Fed rate cuts, with traders betting on at least another 75 basis point reduction from the two-day meeting that starts on March 18, which would take the Fed Funds rate to a range of 0.25% to 0.5%.

However, with bets on subsequent cuts in April and June, with the latter looking at at least a 43% chance that the Fed Funds rate could be pegged at 0% to 0.25%, investors are now gearing up for the first negative interest rates in U.S. history. 

“There’s been one historic cut already and there are signals that the Fed – the world’s de facto central bank – will make deeper cuts imminently," said Nigel Green, founder and CEO of the deVere Group. "As it scrambles to protect the U.S. economy from the far-reaching fallout of the coronavirus, it can be expected that it could take rates back down to zero – emergency territory - in the next few months."

“This then raises the spectre that the Fed will ultimately follow its peers in Europe and Japan by adopting negative interest rates,” he added.

Sweden's Riksbank was the first central bank to deploy negative rates when it set its benchmark repo rate at -0.25% during the peak of the financial crisis in 2009. 

The tactic was followed by other policymakers around the world, mostly notably in Europe, where the ECB lowered its key refinancing rate to 0% in 2014 and set its overnight deposit rate to -0.1%.

That rate has declined further -- to -0.4% -- and investors expect another 10 basis point reduction when the ECB meets next week in Frankfurt, as global economic growth forecasts continue to erode in the face of the coronavirus pandemic. 

The broader economic impact continues to be assessed, with the IMF trimming its global growth forecast by 0.4 percentage points Wednesday, to 2.9%, a level that would be the slowest pace of advance since 2009.

IMF Managing Director Kristalina Georgieva also cautioned that the COVID-19 related pullback could intensify in the coming months, but added that "how far it will fall and how long the impact will be is still difficult to predict".

Still, even if the U.S. economy were to be pulled into the coronavirus maelstrom, DoubleLine Capital CEO Jeffrey Gundlach isn't convinced the Fed would use negative rates to support it.

"I think they cut 50 (basis points) at the next meeting ... in just two weeks ... I think that’s going to happen," he told CNBC Thursday. "I don’t think we go to negative rates. I think Jay Powell understands that negative rates are fatal to global financial system." 

"If we go to negative rates, there will be capital destruction en masse," he warned.

That hasn't stopped President Donald Trump from pushing for more rate reductions, however, as he ratcheted-up pressure on Powell and his colleagues shortly after Tuesday's emergency rate cut with a Tweet that called for "more easing and cutting".

The President has also remarked on many occasions that Germany -- where the entire bund yield curve trades with negative yields -- gets "paid to borrow money" when it issues government bonds to the market, and that the U.S. should mimic such conditions to create a "level playing field".

Powell, however, has thus far resisted the idea.

 "A number of countries around the world, as you know, face the problem of what do you do when your policy rate gets to zero and some of them actually went below zero," Powell told lawmakers on the Senate banking committee earlier this month.  

"The United States chose not to and, I think going forward, our inclination would be to rely on the tools that we did use (such as quantitative easing) as opposed to negative rates," he added 

"Our instinct is that, in the US context, that’s not a tool we’re looking at," Powell said. "The question about intermediation is when you have negative rates, does it wind up creating downward pressure on bank profitability, which limits credit expansion?"

With bond yields tumbling, coronavirus cases accelerating and markets pushing for deeper and faster Fed rates cuts, we may soon find the answer.