Futures started pricing in the possibility last week of the Fed cutting its target rate below zero as soon as December, with the positioning at least in part because of accounting technicalities. The market has since scaled back some of those wagers. But it’s still reflecting the risk of a negative rate in the second quarter of 2021, and eurodollar options trades have emerged that target a Fed rate of minus 0.5 per cent by mid-2021.
These positions are popping up as the economic devastation of the pandemic is becoming painfully clear. Tuesday’s inflation data showed a record monthly drop in core consumer prices, and a sustained trend of declines could exacerbate concern about the risk of deflation, suggesting that even zero rates could start to be restrictive. Meanwhile, the country’s top infectious disease official is warning of the dangers of reopening too soon.
“In a world where the neutral rate is moving lower, at some point in the fall we’ll arrive at a point where fed funds at zero is tight monetary policy,” said Ed-Al Hussainy, a senior strategist at Columbia Threadneedle.