Mid Week Bond Update

Negative Rates: Is the U.S. Next?

Global Thought Leadership
12 February, 2020

Whether, when and how could negative interest rates arrive in the U.S.?

The European Central Bank (ECB) started its real-world experiment with negative nominal interest rates in early June 2014 and has kept the deposit facility below zero ever since.  The Bank of Japan moved its policy balance rate below zero in late January 2016, where it remains. That leaves the Federal Reserve as the lone major central bank with a target policy rate greater than zero, now 1.75%.

Is the U.S. next in line? Are negative rates even possible in the U.S.? And what would it take for the Fed to drive policy rates below zero?

Short-Term Policy Rates: US, Eurozone and Japan

Chart courtesy of Western Asset. Sources: Federal Reserve Board, Haver, as of 31 Dec 2019. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Western Asset’s Michael Bazdarich believes a serious recession would persuade the Fed to drive nominal rates below zero, but concludes that negative rates would be neither effective in boosting growth nor devoid of unanticipated problems.

Among the challenges in the U.S. would be persuading savers and investors to accept negative rates for their deposits, rather than keeping cash out of the banking system – which would complicate the system’s need to keep reserves on hand to satisfy regulatory mandates.

On the Rise: U.S. Household Debt

Often viewed as an indication of consumer confidence, U.S. households increased their aggregate debt by $601 billion in Q4 2019, bringing total indebtedness above $14 trillion for the first time, according to a report by the New York Fed.  Mortgage origination, including refinancings, rose by $120 billion to $9.56 trillion. With 30-year mortgage rates falling by about one percentage point over the past year, buying power improved notably. Mortgages for adults age 18 to 29 rose to the highest level since Q3 2007. Originations for 30-year-olds rose to $210.1 billion last quarter, the highest level since the end of 2005.  Student debt increased to $1.51 trillion from $1.46 trillion at the end of 2018. More than $100 billion in student debt is held by those age 60 and over.

Debt carrying a higher interest rate is an increasing share of total consumer debt; auto debt, having risen for 35 quarters in a row, rose $16 billion from Q3 2019. But almost 5% of auto loans are delinquent by 90 days or more, the highest percentage since Q3 2011, suggesting some households may be running into trouble at the margin.

On the Slide: 3 Month – 10-Year Treasury Yield Curve

After spending most of Q4 2019 in positive territory, a common measure of yield curve slope fell below zero on January 31 and has stayed near that level since.[1] Economic news from the U.S. has been generally positive recently, so blame for the inversion is being placed by some market participants on worries about the future economic impact of the new coronavirus disease, now named COVID-19. With news of its spread changing minute-by-minute, the only certainty is that the situation will continue to change, sometimes in unanticipated ways.

Note: The year for all dates is 2020 unless otherwise indicated


Source: Bloomberg, 2/11/2020. The spread was 2.8 bps as of 2/11/2020, 8:00 PM ET.

Definitions:

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

Inverted yield curve refers to a market condition when yields for longer-maturity bonds have yields which are lower than shorter-maturity issues.

basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

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