Prior Week Summary
The persistent and elevated volatility in the fixed income, commodity, and equity markets has continued in earnest of late, driving Treasury yields to recent lows and market sentiment seemingly lower. For reference, the closing price of the Dow Jones Industrial Average has changed by at least 100 points on all but 6 trading days so far in 2016, leaving the index lower by approximately 8% year-to-date. On an intra-day basis, the 10-year note fell to 1.52% on Thursday, the lowest level at that point of the curve since 2012. At the same time, WTI crude flirted with $26 a barrel on global growth concerns and the expanding macro-economic implications of negative sovereign yields.
Fed Chair Janet Yellen set the stage for last week’s bout of volatility by mentioning that the Fed is evaluating whether or not negative interest rates are appropriate for the U.S by saying “We wouldn’t take negative rates off the table, but we have work to do to judge whether they would be workable here.” As of this writing, the market implied probability of negative rates in the U.S. by the end of 2016 is approximately 7%, as estimated by pricing in the Fed Funds Futures markets. If the Fed were to initiate a negative interest rate policy in response to the financial market turmoil, it would join the roughly 20% of global GDP where negative rates prevail. It is important to point out that it is not clear whether the Fed actually has the legal authority to move into negative territory on the IOER. A main takeaway from the Chairwoman’s testimony to the House and Senate, is that while the Fed is still inclined to believe that economic fundamentals continue to improve sufficiently to justify additional interest rate increases, prevailing market conditions could hamper progress on the objective to move the policy rate further away from the zero lower bound.
The Look Forward
Looking forward to the week ahead, the markets are likely to focus on the release of the minutes of the January FOMC meeting on Wednesday in addition to updated information on producer prices, the housing market, and industrial production throughout the week. The new President of the Minneapolis Fed, Neil Kashkari, is scheduled to give his first public speech at the Brookings Institute on Tuesday on lessons learned from the financial crisis. The Treasury is also expected to auction $7B in 30-yr TIPS on Thursday.