Investment giant Pimco unveils 3 reasons why traders may soon have to pay to own the world's safest bonds - something that's never happened before
- Joachim Fels, the global economic advisor at Pacific Investment Management Co., thinks negative interest rates on US Treasurys are a real possibility in the future. That would be unprecedented.
- Fels believes three cyclical drivers are fueling larger trends that, when combined, will push the natural rate of interest in the US lower.
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Around the globe, more than $14 trillion worth of outstanding debt now trades with a negative yield, accounting for about 25% of the entire market.
The phenomenon - where issuers are getting paid to borrow - was once viewed as an abnormality, but is quickly becoming mainstream. As it stands right now, bonds with negative interest rates attached to them are showing no signs of losing momentum.
Although many have dismissed the idea of negative rates as a far-flung idea, some think there's a real possibility we will see them within US borders - and one prominent economic advisor thinks that possibility is growing stronger by the day.
"Negative yields on US Treasurys could swiftly change from theory to reality," Joachim Fels, the global economic advisor at Pacific Investment Management Co., wrote in a recent blog post. "It is no longer absurd to think that the nominal yield on US Treasury securities could go negative."
Fels paints his thesis of negative-yielding debt within the US around three key cyclical drivers that are pushing lower the natural rate of interest - or the rate that supports full employment and maximum economic output, while keeping inflation at bay.
And he thinks if these trends continue, US Treasurys may soon join the negative-yielding cohort - a development that would dent the appeal of bonds commonly viewed as the world's safest.
That said, Treasury yields still have further to fall. As of 4 p.m. ET on Wednesday, they sat at 1.71%, close to the lowest in three years.
Here are the three cyclical drivers Fels uses to back his thesis:
1. A slowdown in the labor market
"Pimoc's US economist Tiffany Wilding notes, six-month average net monthly payroll gains have now slowed to 140,000 from 225,000 last year," Fels stated.
A slowing labor market translates into increased savings as individuals stockpile emergency cash reserves and become increasingly more risk averse. Excess savings suppresses interest rates.
"With the U.S. labor market cooling off, households are likely to increase precautionary saving in the period ahead, thus adding to the demographically induced saving glut," he added.
2. President Trump's trade war
Fels thinks the latest round of 10% tariffs on $300 billion worth of Chinese goods "raises uncertainty and is likely to induce companies to postpone or slash investment spending (and hiring) further, thus reducing the demand for investable funds."
This notion produces a vicious feedback loop. More uncertainty translates into less demand - and less demand pushes down the natural rate of interest as consumption in the future is favored over consumption today.
On Monday, Fels' thesis was proved true when escalating tensions resulted in major US indices dropping over 3%.
3. The Federal Reserve
"Third, with the natural rate of interest likely falling fast due to all of these developments, the Federal Reserve risks lagging behind, thus effectively tightening the monetary policy stance (measured by actual rates minus the natural rate) rather than easing it," Fels said.
With most majority of global central bank policies nearing 0% or below, many market participants already believe the Fed is behind the curve. Slowing growth calls for lower rates.
"But if the Fed cuts rates all the way back down to zero and restarts quantitative easing, negative yields on U.S. Treasuries could swiftly change from theory to reality," Fels concluded.
When these cyclical trends, combine with the broader secular trends - demographically led savings and technological advancements - a powerful downward force is applied to interest rates.
And for these reasons, Fels thinks negative rates within the US are a real possibility.