Traders see outside chance of U.S. interest rate hitting rock bottom this year

  • Written by MarketWatch
  • Published in Economics

The fed fund futures market could reflect a small chance that the Federal Reserve will embark on a full-blown cutting cycle that could bring rates to zero, traders said, even as U.S. central bankers have said they would stand pat for the foreseeable future.

That doesn’t necessarily mean bond traders foresee doom for the U.S. economy, which most say is likely to continue its steady growth path this year. Rather, in the range of scenarios that investors could face in 2020, there is a risk that a sudden and unforeseen shock could force the Fed into lowering rates several times.

“There are a lot of possible scenarios. Base case, the Fed goes on hold. The next most likely scenario is slower global growth leads to an insurance cut. The third scenario is that something unexpected happens and the Fed cuts rates several times,” said Robert Tipp, chief fixed-income strategist for PGIM Fixed Income, in an interview.

In support of this interpretation, investors say the Fed is unlikely to take small steps if it is confronted with a sudden plunge in growth or inflation.

“Whenever they start cutting, they’re probably going to move to zero. If the outlook has changed enough to cut, they’ll ultimately cut to zero,” Tom Graff, head of fixed income at Brown Advisory, told MarketWatch.

The Fed has cut interest rates three times in quarter percentage point increments last year, and has said it would stay on hold ever since. Recently, senior Fed officials including Chairman Jerome Powell[1] and San Francisco Fed President Mary Daly[2] have also upheld this view.

Read: Fed’s Powell says risks to the U.S. economy remain, particularly from the coronavirus[3]

Nevertheless, the widely shared expectation that the Fed is much more likely to lower rates than raise them has emboldened bond-market bulls who expect a continuation of the three decade long rally in long-term rates.

The 10-year Treasury note yield TMUBMUSD10Y, +1.09%[4]   climbed 3.8 basis points to 1.585% on Tuesday, but less than 40 basis points away from its all-time low of 1.32% set on June 2016. Bond prices move in the opposite direction of yields.

“The risk-reward [tradeoff] is towards rates being tilted lower. If you’re going to be a holder, it’s attractive from a downside basis,” said Graff.

Traders who bet on the future level of interest rates in the fed fund futures market have over the last two weeks priced in between 30 to 40 basis points worth of cuts, based on the price difference between the fed fund future contract expiring at the end of February and the fed fund contract set to mature in December 2020.

But Thanos Bardas, co-head of global investment grade at Neuberger...

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