In investing, trend-following usually refers to the practice of buying securities that have gone up in price and selling those which have gone down on the idea that behavioral biases among market participants have created an enduring market inefficiency. 1 1 Close That’s my one sentence summary of A Century of Evidence on Trend Following Investing. I apologize to my colleagues for that. But that is just a technical definition. In its more common usage, trend-following means doing things which are popular at the time. The previous Wrap-Up looked at negative prices in oil markets. Since then, Fed Funds futures have started pricing a small chance of negative rates in the 2021 contracts. While negative interest rates aren’t new, the Fed has been reluctant to use them in the U.S. Perhaps when oil does something, other markets want to join the trend. 2 2 Close That’s my one sentence summary of You Can’t Always Trend When You Want. I deeply apologize to my colleagues for that.
In Europe, negative rates are a common monetary policy tool. 3 3 Close Japan also employed a watered-down version of negative rates. They are no longer considered either cruel or unusual. 4 4 Close Except perhaps by some savers. When the coronavirus recession hit the continent, many economists thought that rates would go even lower. Instead, policymakers turned to quantitative easing and targeted lending programs which they felt were better suited to the specific economic problems of this crisis. The general sentiment was that further negative rates would do little to offset the lack of liquidity and forced selling in markets. Asset purchases were considered a more direct way of restoring market function. 5 5 Close “ECB’s Stealth Rate Cut Lures Banks to Fund Virus-Hit Economy.” Bloomberg, May 1, 2020. Some economists argued that negative rates may be counterproductive because they hurt bank profitability and discourage lending.
At the end of March, it seemed like the negative rates were passé. We were in the midst of one of the worst financial crises of the past fifty years and the central banks seemed like they had given up on them. Sweden, the first central bank to go negative, had returned to zero and didn’t seem to be all that enthusiastic about the experiment. If a major health crisis wouldn’t send rates lower, what would?
If there’s one thing we’ve learned about crises, it’s that sentiment can change quickly. A month can seem like a decade. It wasn’t long before academics such as Ken Rogoff brought negative rates back into the discussion. English-speaking central bank governors who had previously been among the biggest believers in the zero-lower-bound opened the door to negative rates, if just a crack. 6 6 Close Ireland’s Central bank and the rest of the ECB don’t count. It is kind of strange that the ECB conducts its meeting in English even though Ireland is the only member country where it is a primary language. Incoming Bank of Canada Governor Tiff Macklem crisscrossed his views with those of his predecessor when he said that negative rates could be part of the BoC’s toolkit. He also said that there were some drawbacks to savers, so it didn’t sound like he was warming up for more rate cuts this year. 7 7 Close Initially the USDCAD rallied on his comments but later reversed. The Daddy Mack made USDCAD jump, but then the markets weren’t having any of that. “Canada hands reins of central bank to crisis-era specialist Macklem,” Reuters, May 1, 2020. Bank of England Governor Andrew Bailey refused to rule out negative rates, though he later said that they weren’t considering them right now. 8 8 Close “BoE Not Considering Negative Rates Right Now, Bailey Says.” Bloomberg, May 14, 2020. On the other side of the world, the Reserve Bank of New Zealand says that it is making plans to set up operationally for negative rates, even if it never ends up using them. 9 9 Close “RBNZ Unleashes More Stimulus as Economy Slumps on Lockdown.” Bloomberg, May 12, 2020.
These anglophone central bankers may have an ulterior motive for discussing negative rates. It may be a bluff to keep longer term rates low without resorting to further asset purchases. If investors think negative rates are possible, they may be more willing to buy ten-year bonds yielding 1% than they would be if they thought zero was the floor. In some ways this is more effective than more traditional forms of forward guidance. Usually central bankers make promises to keep rates low, which they have been known to break. 10 10 Close I’m looking at you, Mark Carney. Merely allowing for the possibility of negative rates can achieve the same goal. Former Fed Chairman Ben Bernanke referred to this as “constructive ambiguity,” which is an economist’s way of saying not to show your cards if you don’t want people to know what’s in your hand. 11 11 Close “The New Tools of Monetary Policy.” Brookings, Ben Bernanke, January 4, 2020.
So what does Bernanke’s former employer think of negative rates? As of October, not much. The Fed minutes from that month stated that “all” officials agreed that negative rates were “not an attractive monetary policy tool in the United States.” Since then, just about every Fed official has stated some degree of skepticism. These range from Barkin’s “I haven’t seen anything personally that makes me think they are worth a try here” to Bostic’s “I am not a big fan of going into the negative rate territory.” 12 12 Close “Fed’s Barkin: Negative interest rates not suitable for United States.” Reuters, May 7, 2020. “Powell Slams Door on Trump’s Negative Rates ‘Gift’.” Bloomberg, May 13, 2020. Chairman Powell was asked about it on Wednesday, and he replied bluntly “this is not something we’re looking at.” 13 13 Close “Powell Slams Door on Trump’s Negative Rates ‘Gift’.” Bloomberg, May 13, 2020.
Yet the Fed Funds futures market continues to price in negative rates. It is difficult to reconcile this with the Fed’s comments. Some strategists have argued that it is the result of position liquidation, but the pricing seems to be persistent. Maybe it’s that Powell and other Fed members haven’t completely ruled them out. Perhaps the market is channeling Jim Carrey’s “So you’re telling me there’s a chance?” This wouldn’t be the first time the markets have disagreed with central bank communication, and in some cases market doubts have been proven prescient.
Market participants are only pricing mildly negative rates. The case for rate cuts may be in the changing nature of the economic problems which may unfold. Markets have largely stabilized and are functioning more normally while the economy continues to sputter. By next year, we almost certainly will be seeing some kind of recovery. If this recovery turns out to be slow, negative rates may be a better tool than additional QE. The pricing may also reflect some cynicism over the effectiveness of current measures, though that pricing is not consistent with the recovery in equity markets. Powell’s comments on Wednesday led to a small initial sell off in equities, so it would seem that risk assets like negative rates, at least for now. Nonetheless, it’s unlikely we will see them until the Fed has exhausted its other options. 14 14 Close Or there is a change in leadership, which won’t be for a while. They don’t always follow the trends.
What We Are Watching
Virus Data and High-Frequency Economic Data
As a number of countries and localities move towards gradual removal of economic restrictions, investors seeking to assess the outlook for economic recovery face an unusually challenging task. Scientific understanding of COVID-19 remains highly incomplete, creating uncertainty over how the pandemic will behave as people begin to emerge from various degrees of lockdown. Furthermore, the global recession brought on by the pandemic has few if any historical precedents, which challenges the ability of economists and analysts to forecast how quickly activity will recover as restrictions are eased. In this rapidly evolving environment, daily updates on coronavirus cases in different countries, states, and cities may offer valuable information on the viable pace of “reopening.” If places that have started to reopen earlier see cases surge, it could slow down the pace of normalization more broadly as policymakers seek to prevent the emergence of a second wave. Provided that case counts continue to fall, market participants are likely to place more weight than usual on economic data that is available with less of a time lag than most government releases. Data measuring mobility, traffic, credit card spending, and a range of other economically sensitive items on a daily or weekly basis could prove useful to investors seeking to assess the pace of economic recovery.
U.S. NAHB Home Builders Sentiment (Monday)
Last month, U.S. homebuilder sentiment came in below consensus forecasts and collapsed to a seven-year low as lockdowns constrained buyers’ mobility and construction activity was drastically impaired. With various states partially re-opening in May and construction deemed a “Phase-1” type of activity in many places, homebuilder sentiment may recover somewhat. On the other hand, as concerns of a longer-lasting recession have increased in recent weeks, sentiment in the housing market could remain depressed for a protracted period. The NAHB indicator will provide an update on how homebuilders measure the tailwinds of re-openings and low interest rates against the headwinds of a potentially more protracted economic downturn.
EU PMI (Friday)
Composite PMIs across the Euro Area stood at historical lows in April, as profound disruptions to economic activity due to the lockdowns have caused a significantly deeper contraction in France, Italy and Spain than during the Great Recession. With various European countries easing lockdowns in May, the preliminary PMI to be released next week may show some improvement relative to April. Should PMIs miss market expectations, hopes for a quick rebound in activity would be dampened, which could weigh on European stocks and boost safe-haven sovereign bonds.