Negative rates 'major' catalyst for market woes: Pimco

Low interest rates, then zero rates, then negative rates, seemed like such a good idea as a way for global economies to escape moribund growth. Until they didn't.

That point where financial engineering no longer could pave the way to recovery from the persistent drag of the Great Recession and the global crisis seems to have arrived. The plunge of interest rates not just to the floor but through it and the depths below is coinciding not with global gain but rather the greatest level of market turmoil since the financial crisis ostensibly ended.

It's led some market participants to cry "enough!" and demand that the morphing from zero interest policy, or ZIRP, to negative interest rate policy, or NIRP, stop.

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"Contrary to current central bank dogma, NIRP is possibly one of the major catalysts behind the tightening in global financial conditions," bond giant Pimco wrote in a blistering criticism of central banks.

"While NIRP undoubtedly helps lower government bond yields, which in isolation represents a loosening of financial conditions, it may be causing the opposite effect on overall financial conditions: widening of credit and equity risk premiums, increased volatility and reduced credit availability from a more stressed bank system," analyst Scott A. Mather, CIO of Pimco's U.S. core strategies, said in the report.

Employees of a foreign exchange trading company work under monitors displaying the 10-year Japanese government bond yield in Tokyo, Feb. 9, 2016.
Yuya Shino | Reuters
Employees of a foreign exchange trading company work under monitors displaying the 10-year Japanese government bond yield in Tokyo, Feb. 9, 2016.

While the market had been willing to tolerate NIRP in parts of Europe, the recent move in Japan caused a stir that has turned into a quake as speculation grows that the U.S. Federal Reserve may experiment with negative rates.

Fed Chair Janet Yellen, in congressional testimony this week, did little to dispel rumors of negative rates when she conceded that the monetary policymaking Federal Open Market Committee "wouldn't take those off the table" when considering actions if conditions continue to tighten.

Mather believes negative rates would not yield positive results in the U.S. Rather than increase inflation expectations by trying to encourage banks to lend money stored at the Fed — which would be the initial target of NIRP — the move actually could lower inflation expectations by casting a negative light on hopes for growth.

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In addition, he said investors may recoil if they lose the safe haven of government bonds to balance portfolio risk.

Under NIRP, which could see short-term Treasury yields go negative, "perceived risk-free and other high-quality assets are being removed from the financial system and replaced with riskier, negative-expected-return assets," Maher said. "While that may encourage some investors to take more risk to compensate for loss of income, others will certainly be forced to reduce risk in response."

Finally, the move could exacerbate a global currency war. And should there be a pass-through to savings accounts, it "may cause an increase in savings rates, further hampering near-term growth." Indeed, savings rates have grown during ZIRP as savers need to put away more to compensate for low yields.

Despite having its critics, central banks feel little alternative. The road to normalization seems far bumpier.

Globally speaking, NIRP is "here to stay," Morgan Stanley analysts said in a note to clients examining the pros and cons. One of the significant detriments cited in Europe has been an increase in lending rates to consumers from banks whose margins are pressured by further yield curve compression.

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On market liquidity, which has been a significant concern in the U.S. particularly as tougher bank regulations have kicked in, results in Europe have been "mixed," according to Morgan Stanley. On another key issue, money markets, the $500 billion industry has been "functioning well" in Europe, though it's difficult to gauge how that would translate into the much larger $2.7 trillion U.S. space.

"Negative rates in the U.S. have been discussed before, but could pose more stringent challenges than other countries which have implemented them with more benefits than costs," Morgan Stanley said.

Finally, there's the market consideration. Pimco is not the only firm irritated by the talk of going negative.

"Look at stocks in Europe which are tanking on negative rates. Look at stocks in Japan which are tanking on negative rates. Look at (Deutsche Bank) which is at all-time lows on negative rates," bond king Jeff Gundlach of DoubleLine Capital told CNBC. "Negative rates are the last bullet of monetary policy faith, and they are harming, not helping."