The U.S. Is on the Edge of the Global Negative Interest-Rate Club
(Bloomberg Businessweek) -- Government bonds in Denmark, Germany, Japan, Sweden, and Switzerland carry negative yields—meaning it will cost money for investors to hold them to maturity. A big question for fixed-income markets in 2020 is whether it could happen in the U.S., too.
Bond yields fall when their prices rise, and in August investors piled heavily into U.S. Treasuries, driving yields on the benchmark 10-year bond to a three-year low of 1.43% by early September. Yields have climbed back some since, to around 1.8%, but investors are still getting a razor-thin income for lending to the U.S. government. (Over the past 20 years, the average is 3.5%.) There are several reasons why that matters. First, the yields on these bonds help set the pace for long-term borrowing costs throughout the economy, whether home loans or corporate debt. But they also reflect investors’ sentiments about the economy. And the story these low yields tell isn’t rosy.
One force pulling down bond yields has been the U.S. Federal Reserve’s recent cuts in key short-term interest rates. The central bank has been adding stimulus to the U.S. economy in part because it’s worried about a slowdown in global growth. Meanwhile, the fact that 10-year bond investors are willing to be paid so little suggests they have little fear of inflation, which usually goes hand in hand with a strong expansion.
If the Fed keeps cutting short-term rates back to near zero, where they were from late 2008 to 2015, and also restarts quantitative easing, “negative yields on U.S. Treasuries could swiftly change from theory to reality,” Joachim Fels, global economic adviser at Pacific Investment Management Co., wrote in August. How likely is that scenario? An outside shot. Futures markets are anticipating more Fed rate-cutting from the current target of 1.75% to 2%, perhaps as soon as late October. But zero is several normal-size cuts of 0.25% away.
Even more than usual, the direction of rates may depend on global politics. Bruno Braizinha, U.S. rates strategist for Bank of America Corp., says he sees “meaningful” risks to the economic outlook and even a chance that the 10-year yield may hover near zero by the end of 2020, but a signed U.S.-China trade deal could go a long way toward halting that momentum. And JPMorgan Chase & Co. strategist Jan Loeys foresees the possibility of the benchmark yield reaching zero by 2021, a full year quicker than he previously thought, citing trade tensions and worries about capital spending.
Others think a big drop in yields from here may be hard to get. “It’s going to take a truly big shock to push yields back down on a sustained basis again,” says portfolio manager Scott Kimball, whose team oversees $12 billion for BMO Global Asset Management.
Margaret Steinbach, a fixed-income investment specialist at Capital Group, says, “Global investors are trying to figure out if we are in a midcycle slowdown heading into next year or the beginning of a more protracted downturn. We’re in the camp that this will be a midcycle slowdown, certainly over the next 12 months, and that we are a long way from negative yields unless there’s a severe deterioration in the economic backdrop.”
In addition to borrowers, one more group should be paying attention to yields: investors in fixed-income funds. Since the drop in yields has gone along with rising values for existing bonds, many funds have enjoyed strong returns in the past year, and that would continue if the march toward zero resumes. If the economy finds its footing and yields stabilize—or rise—gains like that will be a thing of the past.
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