A few weeks ago, I (Nick) got a call from Fidelity, where I keep some savings in a US Treasury money market fund account. “Wouldn’t I like to hear about their higher-yielding options?”
With rates where they are, I was surprised it took them as long as it did to reach out to me. I knew that as 3-month Treasury yields went from 1.5% (a 1,000 years ago on February 25th) to almost zero now there would be a lot of pressure to get customers to reallocate their capital elsewhere. When short rates go to zero you can either maintain $1.00/share or charge a management fee, but not both.
I bring that up because today we got an unexpected move in Fed Funds Futures (FFF):
- After weeks of seeming content to hover around expectations of the Fed holding pat at 0-25 basis points until 2022, futures now price some possibility of the central bank moving to negative rates.
- December 2020’s contract went out at 100.01, which implies negative 1 basis point Fed Funds. Using simple decision-tree probabilities, that says there are 4% odds of negative rates in 7 months.
- The largest odds for negative rates are in the June/July 2021 contracts, at an implied 12%.
These moves in Fed Funds Futures spilled over into the Treasury market:
- 2-year Treasury yields fell to 0.139% from 0.18% yesterday, their lowest yields ever. And “ever” includes the last 10 years…
- 5-year Treasuries closed with a 0.305% yield from 0.377% yesterday, also their lowest yields ever.
Now, here’s the thing: Chair Powell has said negative rates are not something he wants, and markets also understand that negative rates cast a pall on the US money market fund system. And, by the way, money market fund assets under management are at record highs just now so it’s hardly a time to stress this particular part of the system.
So then, why did futures flip to forecasting the possibility of negative rates today (emphasis on “today”, because there was no news large enough to explain it). We reached out to our usual sources of information, but no one had any good answers.
In the end, we only know 3 things:
#1: Fed Funds Futures have had a much better track record of calling rate moves than any human economist or market pundit. We don’t do Fed Funds forecasts at DataTrek simply because pointing you to this market more consistently delivers the right answer than any other resource.
#2: It was not just FFF that moved today, but Treasuries – a very liquid market – where prices went places they’ve never been before. It was not just a few wonky trades in futures-land…
#3: I have a new appreciation for why negative rates don’t work. If Treasury yields track to Fed Funds (and they always do), my little nest egg will start to erode in value next year. That will make me either consume less or save more to make up the difference. I know how to do those things, and so does everyone else.
Bottom line: oil going negative last month and the market volatility that caused has taught us all to pay attention to wonky moves in illiquid markets. We’re putting Fed Funds Futures in that same much-watch bucket until it reverts to sensible prices.