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Negative-yield ‘quicksand’ risks trapping even the US bond market

It would be a multi-year process that could be triggered by “a plain-vanilla recession".

Jul 19, 2019, 09.45 AM IST
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The prospect of Treasury yields dropping to zero may seem remote, with the 10-year benchmark now back above 2 per cent, the US jobless rate near a 50-year low and stocks close to record highs.
The world’s almost $13 trillion pile of negative-yielding bonds is looking like “quicksand” that risks engulfing much of the fixed-income universe, including the US, says JPMorgan Chase & Co’s Jan Loeys.

The prospect of Treasury yields dropping to zero may seem remote, with the 10-year benchmark now back above 2 per cent, the US jobless rate near a 50-year low and stocks close to record highs. But Loeys, a senior adviser of long-term investment strategy, lays out a scenario in which that could happen.

It would be a multi-year process, in his view, that could be triggered by “a plain-vanilla recession” caused perhaps by an extended trade war and plummeting capital expenditures. As he sees it, that would push the Federal Reserve to cut rates to zero and resort to quantitative easing again as inflation ebbs. The net result: much lower yields.

“There’s a serious probability that in the next three years US Treasury yields are at zero, if not negative, and the whole market is sitting at zero and negative yields,” said New York-based Loeys, who co-wrote a paper on the topic of zero yields with colleague Shiny Kundu.

The 10-year Treasury yield, a benchmark for global borrowing, has never been below 1.318 per cent, which it dipped to in 2016 in the wake of the UK vote to leave the European Union. The notes gained Wednesday amid losses in stocks, driving the yield down 6 basis points to 2.04 per cent as traders added to bets on Fed rate cuts.

Loeys says investors ought to be prepared for the 10-year yield to dive much lower in at least two stages should the scenario he envisions unfold.

First, as it drops below 1 per cent, they should aggressively buy 30-year bonds while selling the dollar, and initially move away from stocks. Then, once the yield settles around zero, they should turn to higherincome securities, such as dividend-paying stocks, real estate investment trusts and emergingmarket local debt, unhedged for currency swings.

The lesson of the past decade from Japan and Europe is that the “zero and negative-yielding world is like a sand trap,” he said. “The quicksand scenario is a process, not an event, a slow bleed that could take three or four years.”

The 10-year government yields of Switzerland, Germany and Japan -- now at -0.6 per cent, -0.29 per cent and -0.13 per cent, respectively -- are back below zero after clawing above in recent years. The Swiss National Bank, the European Central Bank and the Bank of Japan all have negative policy rates. Economists anticipate additional stimulus from the ECB, while the Fed is widely expected to cut its 2.25 per cent-to-2.5 per cent target range this month and slash it further later in 2019.

A trend of higher US inflation readings like those released last week would reduce the risk of yields eventually hitting zero, according to Loeys.

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