Rates: Getting dumped

In a flash, we find the US 10-year below 1%, and the speed of the move from 1.8% was no doubt a factor behind the emergency 50bp cut delivered by the Federal Reserve. Ahead of delivery, the cut was fully discounted. The Fed just had to turn up and pull that rate cut lever. They did. And now the markets are gunning for at least another 50bp. That would bring the funds rate to the 50bp area. Then the debate starts as to whether the Fed is done, as if they are not, we are then staring down the barrel of the approach of zero rates.

Rate cuts are no panacea for the flu, but they do help to lubricate the financial system

Do zero rates make sense? Not based on what we know. Inflation is at 2% for starters. A -200bp real rate would paint a dire implied market discount for the US economy. What makes more sense to us is a quick dive into negative real rates due to exceptional circumstances that are expected to prove temporary. But as we can't say for sure, there are overshoots. Equity markets getting dumped is one. The exceptional flight into the safety of bonds is another. A rate-cutting Fed then chimes with both.

Think of the Fed cuts as a comfort blanket. Rate cuts are no panacea for the flu, but they do help to lubricate the financial system. As an evitable virus-panic-related-slowdown takes hold, high yield corporates would be the first to come under pressure. Company accounts in the black can quickly move into the red, elevating default risk. Easy access to liquidity is a first defence system. That's why loosening from the Fed is a sensible reaction.

And remember, they can be reversed just as quickly if needed.

In the meantime, exceptional volatility means we are never sure on a day-to-day basis whether we've seen the bottom for rates, or risk assets. The background noise on Covid-19 continues to darken though. It is still in expansion mode, especially outside of Asia. We are not yet at a point where we can look through the rise in infections to a macro recovery. Refuge from warmer months ahead offers the best glint of positivity. But we need to get there first, which likely keeps rates under downward pressure.

We can envisage a series of Ws for risk assets in the coming weeks, more likely with a net slide further lower

As we continue the overshoot to the downside, it is entirely conceivable that the US curve marks out at sub-50bp on the 2-year and the 75bp area in the 10-year. That's based off a comfort factor around the 1% area for the 10-year. A handle of one looks even better when compared with alternatives in risk-free space in deep negative territory. That said, even the German 3-month bubill yield at -0.7% can be an acceptable safe haven relative to the downside that equity markets could suffer should things turn down again.