Negative Yields: It’s obvious where interest rates are headed

Financial markets are certainly encountering challenging times, characterized by slower global growth and rising protectionism.

Sluggish economic growth and lower inflationary expectations have yet again compelled central banks to contemplate at another monetary easing in the form of rate cuts and asset purchases.

Absurdly low-interest rates (read negative bond yields) raise a serious question on how the financial system in advanced economies will protect savings of the households. To wit, sovereign Yields across the globe have moved south, with the value of negative-yielding bonds in the developed world close to $13 trillion, when compared with $8.3 trillion at the beginning of this year.

Around half of Euro sovereign bonds are now trading in negative territory. Despite the prevalence of low interest rates and accommodative central banks for the last ten years, the deep-rooted problem of low inflation and tepid growth remains unresolved.

With signs of deceleration in global macros and concerns over trade, there is a renewed consensus on lower economic growth projections. Though US/China trade negotiations have yielded some concessions, structural issues remain unresolved. Consequentially, central banks are re-aligning monetary policy stance, quite a divergent scenario when compared with the narrative of policy normalization a year back.

Accommodative statements by US Fed, ECB and the Bank of Japan reinforce the easy money massage, as did rate decreases put through by central banks in India, Philippines, Malaysia, Chile, New Zealand, and Australia. Meanwhile, Swiss interest rates are expected to be cut further into negative territory (-0.75 percent now), possibly as soon as early 2020, while Austrian centenary bond (coupon of 2.1 percent) fetches a yield of 2.1 percent.

Central banks which were looking at hiking rates are now doing otherwise. The process of policy normalization by the Fed and ECB is now simply relegated to the back burner for the foreseeable time. A series of rate cuts seem to be a certainty in the US while a fresh round of asset purchases is anticipated in Europe and Japan. China is also compelled to join the bandwagon.

Fed has shifted towards a more dovish stance going forward and pointed to an undetermined number of interest rate cuts in the future, citing uncertain economic outlook. The Fed also downgraded its outlook on the US economy, stating that it no longer sees the economy in solid expansion mode.

While consumer spending and labor growth remains steady, the Fed has concerns about slowing business investment and an uncertain trade outlook. US credit markets have already factored in the overall slowing theme, with futures markets pricing in three-four cuts in the next 12 months.

A flatter yield curve denotes the expectations on the future trajectory of interest rates, inflation, and growth. Lower yields on the longer duration bonds theoretically suggest that the markets are pricing in the possibility of accommodative policy, dovetailed by descending economic growth rate. To give due credit to the prognosis of the bond markets, it is important to note that the US yield curve over the several decades has inverted on most of the occasions ahead of a US recession.

Financial markets are certainly encountering challenging times, characterized by slower global growth and rising protectionism. Nevertheless, falling sovereign bond yields, accommodative and expansionary government policies will provide an element of cushion to the market sentiment, with an immediate need to prop the economy amid an apparent deceleration in aggregate demand.

(The author is Vice President at Yes Securities.)

Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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