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Portfolio > Mutual Funds > Bond Funds

Will US Interest Rates Go Negative?

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Lower for longer but not negative. That’s the general consensus about the direction of U.S. interest rates, which the Fed is expected to support with another 25 basis-point rate cut this week. 

It would be the second consecutive rate cut by the Fed, which reduced rates in late July for the first time in more than 10 years to 2% to 2.25%.

The Fed’s forward guidance will be “the important thing” for investors to follow at this week’s Federal Open Market Committee (FOMC) meeting, says Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. The two-day meeting ends Wednesday afternoon.

Jones, along with many other market economists, is expecting additional Fed rate cuts after one this week to offset the slowdown in the economy and to try to move inflation higher, closer to the Fed’s 2% target rate. She’s expecting at least two more cuts after Wednesday — one this year and one next — but not a turn to negative rates as has been the case for some other developed countries. 

One of those countries — Austria — issued a 100-year government bond two years ago, with a 2.1% coupon. The bond is up over 80% year to date, far more than other investments. 

The low-rate environment and growing federal budget deficit — expected to reach $1 trillion next year — has got the U.S. Treasury considering the issue of an ultra long-term bond.

Last Wednesday U.S. Treasury Secretary Steven Mnuchin said his department was considering issuing 50-year bonds “if there is proper demand” and possibly a 100-year bond if the 50-year bond is successful. An ultra-long maturity bond would allow the government to take advantage of low rates to service its growing debt load, said Mnuchin. (The U.S. budget deficit is poised to top $1 trillion next year, according to the CBO.) The 50-year bond would presumably replace the 30-year Treasury for new issues.

Earlier on Wednesday the European Central Bank cut a key interest rate slightly from -0.4% to -0.5% and announced a new round of bond purchases, also known as quantitative easing, and more favorable terms for a refinancing facility for eurozone banks. Many banks in Europe will now have to pay 0.5% interest for deposits at the ECB. 

The ECB move added “more downward pressure on U.S. yields,” says Jurrien Timmer, the director of global macro in Fidelity’s global asset allocation division.

But it won’t lead the Fed to adopt negative interest rates now, without a recession, credit crunch or deflation, according to Jones. “There is no reason for the Fed to go negative,” said Jones, adding that negative rates hurts the banking sector and may not be legal, according to Janet Yellen, who as Fed chairwoman said the legality of such a move would have to be researched.

That hasn’t stopped President Donald Trump from pushing recently for zero to negative interest rates and from continuing to insult its chairman, Jerome Powell. Negative rates in Europe and Japan, which have persisted for several years, however, have not reversed their weak economies though they might have been weaker without them.

The challenge for those economies and the U.S. economy now, says Jones, is how to stimulate demand when populations are aging, the Chinese economy is slowing and trade wars persist. Monetary policy can’t solve those issues, she says.

“Demographics have more to do with falling rates than people acknowledge” and “negative rates don’t work,” says Fidelity’s Timmer. They don’t create demand or lead to more spending and can instead add to consumers’ worries, causing them to spend less and save more. “The savings rate has gone way up,” notes Timmer. The U.S. savings rate has been close to 8% since early 2018.

— Check out Bob Doll’s 5 Themes for Stock Investors for the Next Year on ThinkAdvisor.


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