U.S. markets closed

Negative Interest Rates Coming To US?

Negative Interest Rates Coming To US?

Yields on benchmark Treasuries have been volatile to say the least. After plunging to record lows a little over a week ago, bond yields have been on the rise recently.

The 10-year bond yield dipped an astonishingly low 0.31% on March 9. On March 19, it traded as high as 1.27%, a fourfold increase.

10-Year Treasury Bond Yield

 

What Happened

The initial move lower was sparked by panic buying of Treasuries as investors sought shelter from plunging equity markets and the fast-spreading coronavirus (bond prices and yields move inversely). Anticipation of a big Fed rate cut—which took place in a surprise meeting on Sunday, March 15—also fueled the plunge in yields.

Then, as equities continued to crash, investors sought to raise cash anywhere they could find it, including Treasuries, one of the few areas still up for the year. The reversal in yields was exacerbated as details of a potential $1.3 trillion coronavirus aid package from the U.S. government emerged (the government will have to issue bonds to pay for the package, increasing Treasury supply).

The push and pull of these factors—along with the Fed’s new QE program—muddy the outlook for Treasuries. Has the low in yields been reached? Or are they headed even lower?

Future Fed Action

Where rates go from here will largely depend on how the coronavirus crisis develops and what the Fed does moving forward. The central bank mentioned that it has more tools in its toolkit and that it stands ready to take further action should it be warranted.

But at least so far, the Fed is reluctant to wade into the negative-rate waters as other central banks have done. In a press conference after the March 15 decision, Fed Chairman Powell said that forward guidance and asset purchases are the basic elements of the Fed’s toolkit once rates hit the lower bound of zero.

“We do not see negative policy rates as likely to be an appropriate policy response here in the United States,” he said.

Does that mean negative rates are completely off the table in the U.S.? Or could they still go there? After all, Treasury bond rates are set by the market. Even if the Fed doesn’t want to cut its benchmark federal funds rate to negative territory, conceivably, market-determined rates could slip below zero.

What Analysts Are Saying
“Although the potential for U.S. interest rates to go negative are still remote, the probability has climbed significantly in the last two weeks,” said Michael Arone, chief investment strategist at State Street Global Advisors.

Arone says that current rates are reflecting much slower global economic growth, if not outright recession.

Gary Stringer, chief investment officer for Stringer Asset Management, agrees: “Yes, U.S. interest rates can go negative in theory, but we do not think that we will see that.”




“Negative nominal long-term interest rates are a reflection of slow economic growth and low inflation in some of the major foreign economies,” he added. “We expect the U.S. to experience both faster economic growth and higher inflation than those economies with negative long-term interest rates, though both of these measures should remain low by historical standards.”

What Negative Rates Could Mean

While most analysts aren’t predicting negative rates in the U.S., if that does happen, it could have significant ramifications for markets and investors.

“With roughly $14 trillion in negative yielding debt around the globe, investors have become desensitized to a fixed income environment with negative yields,” Arone said. “However, negative U.S. yields would be unprecedented in history. It’s difficult to imagine the world’s reserve currency offering fixed income investors negative yields. Counterintuitively, the shock of negative rates in the U.S. might result in a massive increase in the demand for perceived safe havens, pushing yields for Treasuries even lower.”

Meanwhile, Stringer says that negative rates would negatively impact depository institutions like banks; likewise, they would hurt individual investors. However, as he pointed out, on an inflation adjusted-basis, real interest rates are already negative in the U.S.

What To Do
With negative interest rates unlikely, but possible, what should investors do?

State Street’s Arone suggests taking a look at conservative active fixed income ETFs. These funds “may be able to more delicately balance the interest rate and credit risks inherent in today’s fluid investing environment,” he said.

Arone recommends the SPDR DoubleLine Total Return Tactical ETF (TOTL), which offers a higher yield than the Barclays Bloomberg Aggregate Index, with a lower duration profile.

In addition, with yields so low and a wildly uncertain investing landscape, investors may want to consider the actively managed SPDR SSGA Ultra Short Term Bond ETF (ULST). It offers investors professional money management with a competitive yield and short duration.

Meanwhile, Stringer is most concerned about credit spreads widening “given the current economic and geopolitical backdrop, especially with risks to the energy space.” He favors high quality mortgage-backed securities as well as short-term Treasuries in the current environment.








Email Sumit Roy at sroy@etf.com or follow him on Twitter @sumitroy2

Recommended Stories


Permalink | © Copyright 2020 ETF.com. All rights reserved