Negative-yielding sovereign debt levels now exceed $15 trillion, and negative-yielding corporate debt is now greater than $1 trillion around the world.
With the Federal Reserve cutting interest rates for the second time this year, investors are growing increasingly concerned that U.S. interest rates may drop below zero during the next market downturn.
LPL Financial Chief Investment Strategist John Lynch recently said the mentality for fixed-income investors around the world has shifted from how to earn more income to how to avoid losing more principal.
Several theories exist as to why negative yields have become so popular, Lynch said. Some experts suggest rates are being forced into negative territory due to a glut in global saving. Others say an aging global population is driving rates below zero. Still others blame a global shift toward instant gratification and a change in mentality away from long-term returns.
At some point along the line, interest rate cuts in regions like Japan and Europe shifted from being a way to encourage investing over saving to a way to force savers to invest rather than risk losing money to negative rates.
While the U.S. has avoided negative yields up to this point, U.S. Treasuries are paying near record-low yields despite a late-stage economic expansion.
The U.S. economy is healthy enough to support much higher yields, Lynch said. Yet ultra-low and negative rates around the world are also driving U.S. rates down as well.
Will U.S. Rates Fall Below Zero?
Former Fed Chair Alan Greenspan recently spooked investors when he said there is theoretically nothing keeping U.S. interest rates in positive territory.
“There is no barrier for U.S. Treasury yields going below zero. Zero has no meaning, beside being a certain level,” Greenspan said.
Lynch said there are reasons U.S. rates will stay above zero, at least for the time being.
“Given the U.S. economy’s resilience and the already low policy rate, we do not expect the Fed to take rates much lower than the 1.5% threshold,” he said. “Indeed, policymakers want to ensure enough wiggle room to adjust rates further when a recession may appear more likely.”
He said 1% could be the new bottom for the U.S. Fed funds rate.
'Not Out Of The Question'
Joe Brusuelas, chief economist at RSM US LLP, told Benzinga that investors shouldn’t rule out the possibility of negative U.S. interest rates at some point down the line.
“Given the downward drift of yield curves around the world, should there be a financial crisis or a major exogenous supply shock, the probability of a negative nominal policy rate is not out of the question,” Brusuelas said.
“Real negative yields have long been a policy tool of the Fed, and given the period of slow growth and low inflation ahead in the advanced economies, the probability of negative yields on government and corporate debt is rising.”
Allianz Chief Economic Adviser Mohamed El-Erian told Benzinga that ventures into negative rate territory around the world have had mixed results.
“Where market interest rates go from here will be a function of two main factors: how far will the Fed go in cutting policy rates and the depth of the global economic slowdown,” he said.
“On the first issue, it is unlikely that the Fed will follow the ECB in adopting negative policy rates. Internal research, as well as increasing evidence from the eurozone, shows that protracted negative rates can cause more harm than good.”
The U.S. bond market is pricing in a 48% chance the Fed will cut interest rates by at least 0.5% from their current level by the end of the year, according to CME Group. That projection suggests at least one more rate cut this year, even after the Fed issued a 0.25% cut Wednesday.
So far, U.S. stock investors have mostly shrugged off the Fed’s rate cuts. Since the Fed first cut rates back in late July, the SPDR S&P 500 ETF Trust SPY is up about 1%.
Based on the commentary from market experts, it would likely take an extreme economic shock to push U.S. interest rates into negative territory anytime soon. In the meantime, investors should pay close attention to U.S. economic numbers for any signs of the next potential recession.
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