Traders Are Baffled Why the Futures Market Is Pricing in Negative Rates  

(Bloomberg) -- The futures market is again pricing in the possibility of the U.S. joining Europe and Japan with negative rates, catching money managers, traders and analysts off guard.

Expectations for the timing of below-zero rates -- as shown by contracts on the Fed funds rate -- shifted to the middle of 2021 after earlier indicating this scenario as soon as December amid dour jobs data that showed the worst employment downturn in U.S. history. But investors are still trying to figure out why markets have so rapidly embraced a theme that’s an anathema to many.

The timing is certainly odd. Despite continuing evidence of the economic damage caused by the coronavirus, investors have been embracing risk and volatility gauges are either falling or relatively stable in the past two days. In addition, Federal Reserve bank officials are still dismissing the notion of negative rates, while large investors don’t see the scenario happening and the consequences of any such move could be disastrous.

“I am surprised to see some of these expectations for negative rates so soon after the Fed has done so much, from significant asset purchase programs to zero rates and flooding the economy with liquidity,” said Larry Milstein, head of government debt trading at R.W. Pressprich & Co. in New York. “I would have thought that the market would wait to see how this all plays out, yet some investors think the Fed doesn’t have many more levers left.”

However, record-low yields are pointing to an undercurrent of worry in the market, with Scott Minerd, global chief investment officer of Guggenheim Partners, saying Friday that declining Treasury yields indicate negative rates could soon be here. Plus recent dramatic falls in one-month and three-month London interbank offered rates, on top of an influx of cash into money-market funds, may have prompted reluctant traders to begin fretting about the possibility of ever lower rates and to move up those expectations, even if only to hedge the risk, according to Jim Vogel, who manages fixed-income strategy at FHN Financial Capital Markets.

Still others see a litany of other possible reasons behind the market’s thinking that range from technical factors, such as stop-outs of short positions, to bank-hedging flows and -- more broadly -- growing deflation fears. Memories of April’s collapse in oil prices, due to too much supply and too little storage space, may have also offered an early glimpse into how low rates could get even for those holding out hope the Fed never goes there.

Billionaire Jeffrey Gundlach, co-founder of DoubleLine Capital, warning in a late Wednesday tweet about building pressures on fed funds to go negative along with the “fatal” consequences may have brought the expectations to the fore, according to Milstein.

Tony Farren, managing director at broker-dealer Mischler Financial in Stamford, Connecticut, expected it might take until August for the market to begin pricing in negative U.S. rates. In that late summer scenario, expectations for the economy to come “roaring back” instead fizzle out, inflation stays extreme low or turns into deflation, and Treasury yields across the board all make a run for zero.

“I’m still searching for a reason and see no reason why fed funds futures should have gone negative now,” he said. “I’m at a loss.”

©2020 Bloomberg L.P.