Futures market and negative Fed rate – What’s in store for the next 12 months?

Futures market and negative Fed rate – What’s in store for the next 12 months?

International shares surged with a rally in the US stock market as China signalled that its US-China phase-1 trade deal remained on track and the economies restarted. The shares surged even after the unemployment rate rose to a staggering 14.7% in April with a record loss of 20.5 million jobs, reflecting optimistic attitudes of investors in relation to coronavirus.

On 8 May, Nasdaq Composite gained 1.58%, S&P 500 soared 1.69%, and Dow Jones Industrial Average climbed 1.9% indicating that investors are betting that the worst phase of coronavirus has passed now.

In the futures market, S&P 500 Futures rallied 1.75%, while Dow Jones 30 futures rose 1.93% after US-China phone call comforting investors by giving them some optimism. European shares surged with Stoxx Europe 600 Index rising to 0.91%, pulled by construction and industrial stocks and shares in cars and auto parts manufacturers.

In Asia, Hong Kong’s Hang Sang Futures Index rallied 1.40% while Japan’s Nikkei 225 futures rose 2.75% as investors centred on US-China talks and robust corporate earnings instead of focussing on the worst US unemployment rate data released on 8 May.

US President Donald Trump had threatened to terminate the US-China trade deal if China failed to live up to its commitment of increasing purchases of goods and services from the US by minimum US$200 billion in the next two years. The trade negotiators in the US and China discussed on the phone on 8 May, and China promised to improve the atmosphere for its enactment, which offered some relief to investors and led to the market rally.

This also helped oil to rebound its lows. WTI for June delivery rose 4.54% to settle at US$24.62 a barrel on the hopes that easing lockdowns will lift demand.

The market movement suggests that investors are able to judge the negative economic data and are well aware of the grave consequences that can follow if the virus cases surge. However, they are also optimistic and can look through the potential of gradual recovery and reopening of the economy. Next thing to worry for the market is the unnerving process of restarting the economy and bringing them to pre-COVID-19 levels which can take years.

Fed’s actions amid COVID-19

The US Central Bank, Federal Reserve, has taken rigorous measures to keep the economy going and markets buoyant. On 3 March, the Fed made an emergency rate cut of 50 bps followed by another 1% cut pushing interest rates to almost 0 on 15 March. Further, Fed lowered the rate for banks to borrow by 150 bps and cut the reserve requirement for banks to 0.

In addition to cutting interest rates to 0, Fed announced a quantitative easing program where it started buying commercial paper or short-term unsecured debt. Primarily, the Fed committed to buying US$500 billion in Treasury securities and US$200 billion in mortgage-backed securities that were government guaranteed. However, it later made an open-ended purchase of securities. Also, the Fed made US dollars accessible to central banks of other countries so that they are able to offer loans to banks that are in need.

As the Fed cannot alone cope up with the economic fallout of COVID-19, there has been a minimum of US$2 trillion fiscal response from Congress and the President to support businesses and households.

Will Fed push rates into negative terrain?

The traders are anticipating that Federal Reserve might cut the policy rate below 0 by December 2020 until at least January 2022 pulling the yield on Treasuries to a historic low.

US treasury yield has gone into the negative field with 10-2 Year Treasury Yield Spread Bond Yield falling 3.33% on 8 May, lowest on record.

Market experts believe that there is a ‘1 in 3’ chance of rates to turn negative in the next year due to worries that Fed is left with no more tools to shield the economy and protect financial markets from the raging impact of COVID-19 on the economy.

ALSO READ: Has the Fed fired its last bullet? Welcome to the World of Zero interest rate

President and CEO of Richmond Fed, Mr Tom Barkin stated that he does not anticipate negative interest rates, citing them as inappropriate for the US. He added that negative interest rates had been attempted in other places, but there seems to be no need to implement it in the US. Fed chairperson Jerome Powell also opined that negative interest rates are not a suitable policy for the country.

Fed Fund Futures assess where market anticipates Fed’s overnight benchmark lending rate to be. Fed fund futures have been breaching 100 mark, reaching a high of 100.04 on 8 May with a low of 98.755 on 13 February, in the preceding three months pricing negative rates in Jan 2021. The numbers indicated anticipation of a policy rate fractionally below 0 next year showing substantial need for astonishing levels of monetary support for the economy that should be rebound in 2021.


Source: Thomson Reuters

If financial institutions have excess reserves, i.e. cash beyond the levels stated by the regulators, they are obliged to pay interest to keep them with the central bank under a negative interest rate policy. This move is to prompt banks not to hold much cash and lend money to firms and consumers instead. Central banks of Europe and Japan have adopted negative rates in the past, but the Fed seems unlikely to do so.

US economy is facing the worst economic downturn due to stimulus measures taken up by the government to wriggle out the economy from the coronavirus pandemic. With 33.5 million people filing for jobless claims and unemployment rate spiking to 14.7% in April from 4.4% in March, the situation has worsened considerably.

Outlook ahead

The coronavirus pandemic can affect the economy further, making conditions even worse than those during the Great Depression. However, the actions taken by the Federal Reserve, combined with the fiscal response provided by the government have shielded us from a repeat of that event happening again.

Hence, the majority of the market believes negative interest rates will be implausible as it can lead to collapsing of money market funds along with political consequences.

 


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