Morgan Stanley with a note:
Intuition behind shady short bets
The shadow short-term rate (SSR) is an estimate of what the central bank’s standard overnight interest rate would be if it explored the depth of negative interest rates instead of pursuing other, unconventional policies such as quantitative easing or enhanced forward-looking guidance. which would lower long-term rates. instead. We can interpret the difference between SSR and the actual overnight discount rate as the value of unconventional political maneuvers in unconventional policy terms.
The difference also reflects the value of the option that investors should keep in cash, rather than bonds, whose yields are constrained by central bank policy. Basically, SSR is a cash yield that will make investors indifferent between holding lower-yield bonds and cash.
How can investors use shadow short rates?
We found that differences between regional SSRs better explain currency movements than differences in nominal exchange rates. SSRs allow investors to easily compare the monetary policy stance of central banks that have cut rates to (or closed) the effective floor. Understanding them is critical as traditional monetary policy increasingly faces an effective lower bound (ELB).
Forecasting with shadow short rates
Our up and down bond yield forecasts are based on multifaceted scenarios reflecting our expected global and domestic growth trajectories, economic and government policy assumptions, and our expectations of investor demand for risk. However, we can use our bullish scenario as a proxy for how the Treasury curve might develop if the Fed takes a more dovish policy path (for example, by expanding WAM for its asset purchases) or if the market is surprised. that the Fed is not going to be more aggressive (Exhibit 19). We note that the timing at which the Fed announces and executes the rate is a key variable in our bullish and bearish outlooks. Likewise, we could use our Treasury bearish forecasts as an example of how much the curve could rise if the Fed signals a relatively hasty cut in its purchases in the coming months.
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