Negative interest rates have been in the news this year and have been the source of questions from clients. Negative Interest rates are an extraordinarily unusual phenomenon where an investor pays for the “privilege” of loaning a country money. Buying a negative yielding bond guarantees that an investor will lose money if they hold it to maturity. One of the most respected works on the topic of interest rates is a book authored by Sidney Homer and Richard Sylla called, A History of Interest Rates. This book which, is 736 pages of light reading, covers 5000 years of interest rate history starting in ancient times and goes through 2005 when the book was published. Notably, there were no periods of negative interest rates covered in this text. In short, this is a recent phenomenon.
Worldwide, at this writing there are $12 trillion in bonds with negative yields. These bonds are the sovereign debt issued by countries around the world, but primarily in Europe. Falling bond yields are generally interpreted as a flight to safety when investors are seeking a safe asset due to slowing in an economy. The amount of negative debt in the world peaked out at $17 trillion in August of this year. The greater the amount of negative yielding debt, the greater the fear amongst investors of slowing economies and possible economic recessions. The decline in negative yielding debt is seen as a positive sign for the world economy as it reflects a more optimistic outlook by investors. To that end, economic growth in Europe while still extremely slow, looks to be stabilizing.
Another question that we receive frequently from our clients is about the prospect of negative interest rates occurring here in the United States. The prospect of longer-term interest rates such that on the 10-year U.S. Treasury falling to a negative yield is highly unlikely. The 10-year U.S. Treasury currently yields 1.83 percent; there would need to be a severe "black swan" event to cause this to happen. A “black swan” event would be a shock to the system that causes a severe economic slowdown. In this scenario investors would pile into the safety of long-term treasury bonds, potentially driving the yield below zero. The U.S. economy is a dynamic and resilient service economy with 70 percent of GDP or national income produced by consumption. Short-term interest rates set by the Federal Reserve could go negative during a severe recession in which the Federal Reserve aggressively attempts to stimulate the economy. There have been instances of negative interest rates on short-term Treasury bills in the past. However, the prospect of persistent negative longer-term interest rates in the United States is highly unlikely.
For the week, the S&P 500 index declined about one percent through Thursday and then rebounded sharply on Friday on the strength of a November employment report that exceeded expectations. Despite some noise in the data from the General Motors strike, non-farm payrolls increased by 266,000 jobs … which was well ahead of expectations. In addition, the unemployment rate dropped to 3.5 percent, the lowest level in 50 years.
Takeaways from the Week:
The decline of negative yielding debt worldwide is a positive sign for global economic growth expectations
Despite slowing economic growth, the U.S. consumer is employed, enjoying wage gains and continues to be the bright spot in the world economy