May 12, 2020 / 2:23 AM / 17 days ago

Two-year yields hit record lows, fed fund futures imply negative rates

NEW YORK (Reuters) - Two-year Treasury yields hit record lows on Friday and fed fund futures implied the Federal Reserve could cut rates into negative territory, though analysts said the move was likely technical as investors betting on higher rates were squeezed out of their positions.

The move came after data on Friday showed the U.S. economy lost a staggering 20.5 million jobs in April, the steepest plunge in payrolls since the Great Depression and the starkest sign yet of how the novel coronavirus pandemic is battering the world’s biggest economy.

Futures show negative Fed policy rates by Dec 2020 here

The rally faded in afternoon trading as investors repositioned ahead of the weekend.

Investors are evaluating how long it will take for the economy to recover, and how much more fiscal and monetary stimulus will be needed to spur growth.

The Fed in March cut rates to zero and has launched numerous lending programs meant to blunt the economic impact of business shutdowns.

But U.S. central bank officials including Chairman Jerome Powell have talked down the likelihood of adopting a negative rate policy.

“The Fed has consistently said they’re not interested in negative rates,” said Robert Tipp, chief investment strategist at PGIM Fixed Income.

Optimism that the economy is closer to reopening has boosted risk assets this week and led some investors to bet that yields could rise from historic lows.

The sharp price rally in short-dated debt, however, is likely due to these investors having to cover their positions as the market moved against them.

“What can happen is when rates get lower and lower, and the Fed is flooding the markets with liquidity, is you can get people that are forced to take those trades off,” Tipp said.

Two-year yields dropped to as low as 0.105%, before rising back to 0.1508%.

The yields hit their lows after White House economic adviser Larry Kudlow said the White House will not consider any further stimulus legislation this month as it watches the economic impact from reopening U.S. states.

Fed fund futures earlier on Friday showed that the U.S. central bank could be forced to cut rates into negative territory by December, but the probability moved back to April 2021 in afternoon trading.

The Fed is reluctant to adopt negative rates due to concerns such a move may not be effective in stimulating growth, and because it may disrupt the banking system and U.S. money markets.

“We have a money market fund industry whose business model would come under severe strain if rates were negative,” UBS strategists led by Michael Cloherty said in a report.

The Fed could face pressure to either adopt negative rates or guide the market away from the possibility, however, if markets continue to price for the scenario.

“The risk from the Fed’s perspective is that this price action starts to become cemented, and so it becomes a bit of a self-fulfilling loop. Or they’re going to effectively have to implement a hawkish forward guidance,” said Jon Hill, an interest rate strategist at BMO Capital Markets in New York.

Benchmark 10-year note yields were last 0.680%, after falling to 0.607% earlier on Friday. The yields have held in a tight band between 0.543% and 0.785% since the beginning of April.

Additional reporting by Kate Duguid; Editing by Chris Reese and Sonya Hepinstall

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