Neal G. Davis, CFA
Senior Portfolio Manager & Research Analyst
Interest rates have been trending downward for nearly the past 40 years. In January of 2000, the 10-year U.S. treasury lingered around 6.0%. Today, the 10-year Treasury yield is markedly lower and near historic lows at 1.75%. It begs the question then, are ultra-low interest rates the new normal?
While interest rates in the U.S. remain muted, they stand out as a reasonably attractive investment option given rates are still north of zero percent. In fact, the global economy is experiencing a relatively recent phenomenon of negative interest rates. Roughly $17 trillion of global debt is in negative interest rate territory. This means that investors are willing to pay governments and corporations for the privilege of lending them money. The bulk of this debt exists in Euros, while much of the remainder is denominated in Japanese Yen. The negative yielding debt represents over 25% of the worldwide bond market. Prior to the financial crisis in 2008, the thought of negative yielding bonds was certainly a farfetched idea.
The Fed has shown reluctance when questioned if they would ever target negative rates. It would be more likely that the Fed would restart quantitative easing (purchasing Treasuries and mortgage-backed securities to place pressure on long-term interest rates) or utilize other measures in the toolkit before reaching that point.
While negative interest rates are unlikely in the U.S., there are a handful of reasons why interest rates could remain low for the foreseeable future. In the near-term, the Fed will likely continue to keep interest rates contained, with another rate cut expected at their next meeting in several weeks. Furthermore, the global economy is amid a slowdown and investors are shifting away from riskier assets and into the safe haven of bonds. As market participants move into bonds, they push interest rates lower due to supply and demand dynamics. Moreover, as baby boomers retire, this translates into more savers. As investors are increasing their savings, they are doing so by purchasing bonds as a safe asset class, thus pushing yields lower as they bid up the prices. Lastly, inflation has been contained, negating any action from the Fed to boost interest rates.
Exceptionally low interest rates can be advantageous or unfavorable to public entities, individuals or governments. Businesses can benefit as they are able to borrow and then purchase equipment, acquire companies, and buy back shares more cheaply. Individuals can purchase and refinance their homes, cars, or make other large purchases at lower rates. The U.S. government also benefits as they can issue new debt at near record lows. Conversely, individuals and pensions suffer as they find it increasingly difficult to achieve a meaningful rate of return on their bond portfolios. Similarly, banks and insurance companies are challenged by low rates due to the decreased net interest margin, or the spread over which they lend, and the interest that they pay on deposits.
As we embark on this new era of ultra-low interest rates, only time will tell whether this is a temporary phenomenon, or it will be here for years to come. Meanwhile, we will continue to analyze and adjust our tactical strategy, as appropriate, in this new ultra-low rate environment to achieve the best results for our clients.
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.