Calls Persist for Negative U.S. Yields Even as Fed Signals Pause
An eagle sculpture stands on the facade of the Marriner S. Eccles Federal Reserve building in Washington, D.C. (Photographer: Andrew Harrer/Bloomberg)

Calls Persist for Negative U.S. Yields Even as Fed Signals Pause

(Bloomberg) -- The Federal Reserve may be hinting at a pause in its policy easing, but Bruno Braizinha at Bank of America Corp. sees a risk that yields on some Treasuries will go negative by 2021 as the U.S. central bank cuts rates all the way to zero.

While that may seem like a remote scenario to some, the strategist says the market can’t ignore the possibility that 5- and 7-year yields -- both presently within a few basis points of 1.60% -- could fall below zero. He says now’s the time to hedge against that prospect.

Braizinha wrote about the risk of sub-1% yields in the U.S. just ahead of August’s historic Treasuries rally, which drove 10-year yields as low as 1.43% on Sept. 3. That rate has since rebounded to around 1.71%, but his central view is that the benchmark yield will go even lower -- to around 1.25% -- in the next three months. In addition to that, he also sees the Fed being forced to return to near-zero rates amid a deterioration in the American economy and an eventual realization by investors that a U.S.-China trade deal won’t be a panacea.

Calls Persist for Negative U.S. Yields Even as Fed Signals Pause

“It’s important to acknowledge those risks and not overlook these scenarios,” he said by phone. “All the positive sentiment on trade is fading, and what’s changed now is that it’s more likely that at some point the Fed is going to have to cut again.”

A day after the Fed signaled a pause on Oct. 30, yields plummeted across the curve. In Braizinha’s view, the moves reflected a bias that permeated the bond market based on expectations for worsening economic data, lower yields and a flatter curve.

Yields regained some of that ground on Friday amid stronger-than-expected American jobs data and positive developments on the U.S.-China trade relationship, although a poor reading on the Institute for Supply Management’s factory gauge created a slightly more mixed view.

To get to negative yields in the belly of the curve, Braizinha says the Fed would need to push its target to around zero -- from 1.50% to 1.75% currently -- like it did a decade ago in the midst of the global financial crisis. Rates on Treasuries out to around three years would then be “anchored around 10 basis points to 15 basis points” in his view, while demand for dollar duration would send 5- and 7-year yields negative.

The Bank of America analyst, who recommends betting on 30-year Treasuries in anticipation that yields will go much lower, is not alone in contemplating negative Treasury yields.

Ryan Sweet, head of monetary policy research at Moody’s Analytics, said he also sees a risk that Treasury yields could go below zero if the U.S. falls into recession. And, according to him, this could happen even if the Fed doesn’t cut its target below zero.

In the options market, meanwhile, some traders have been hedging in the past month against the possibility of U.S. policy rates heading to zero or even negative levels.

Bank of America currently expects one additional Fed rate cut in the first quarter and “there are still many hurdles to get to negative interest rate policy in the U.S.,” according to Braizinha. One of these is that “it is not clear that it worked as it was intended” in other economies.

“What I find more likely is that we reach a policy exhaustion point where the Fed cuts down to near zero, which requires only six 25-basis-point moves, and the curve continues to be pressured by lower long-term inflation expectations and global duration demand,” he said.

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