Over the course of the past decade as part of the recovery from the Global Financial Crisis, we have witnessed an economic phenomenon that has been most unusual—negative interest rates. Indeed, interest rates on sovereign bonds in Europe have once again fallen below zero in 2019.
The German 10-year bond has now spent a record number of days in negative territory, according to Reuters. The German 10-year yield was most recently quoted at -0.40%. The Swiss 10-year bond most recently yielded -0.72%, close to all-time lows. Bloomberg estimates that $13 trillion of global debt now holds a negative interest rate.
The concept of negative interest rates is counter-intuitive. The global system of finance relies on paying interest for the use of capital. Typically when we lend money to another party, we expect to be compensated for lending this money through the payment of interest. Moreover, when we borrow money, whether for a home, a car or college tuition, we expect to pay interest on the borrowed capital. Traditional financial incentives become skewed when interest rates drop below zero.
What is happening in Europe and Japan, where we now see negative interest rates? The short answer is a precipitous drop in inflation expectations. The prospect of deflation, and not inflation, in the Eurozone and Japan is now being reflected in their yields. Through a combination of slowing economic growth and a declining and aging population, bond yields have been pressured lower. In Japan, deflation has been a very real part of their economy over the past fifteen years.
For a variety of reasons, central banks in Europe and Japan want to spur on economic growth and return to inflation. While the US stopped its bond buying program, known as quantitative easing (QE), some time ago, the European Central Bank and the Bank of Japan are still engaging in the practice. In theory the practice of bond buying should be highly inflationary, though the results have been rather subdued in Europe and Japan.
Ramifications for U.S. Markets
Bond yields in the US are likely to remain on the lower side in the foreseeable future, due to the negative yields of bonds in Europe and Japan. At 2.03%, the US 10-year Treasury bond has a very low yield by historical standards. That said, global investors will find this 2.03% yield quite attractive, relative to negative rates in Germany and Japan. If the spread between European and US bonds widens, foreign bond buyers will continue to have a voracious demand for US bonds—keeping a lid on rising rates domestically.
Lower interest rates here at home can be both a negative and a positive. Lower bond yields make it harder for savers and retirees to earn a reasonable return on their bond portfolio. But lower interest rates also make stocks more attractive, while improving consumer balance sheets and reducing debt payments. US consumers continue to be in a very healthy place and this has been reflected in solid economic growth in the first two quarters of 2019.
We continue to monitor financial markets, particularly with respect to global interest rates. Our focus remains on the long-term success of our clients. To this end, maintaining a healthy allocation to high quality bonds is an important consideration—even in light of lower interest rates. Click here to learn more about creating a comprehensive strategy to meet your cash flow needs.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.