A trader works on the trading floor at the New York Stock Exchange, March 5, 2020.
Andrew Kelly | Reuters
The steep plunge in interest rates this week is reflecting fear about the future and also is planting seeds for a recovery once the coronavirus scare subsides.
Government bond yields have reached what were once unthinkable levels. The benchmark 10-year U.S. note briefly fell below 0.7% on Friday, a level more consistent with slow-growing European economies or Japan rather than a country that has been one of the brightest spots on the global landscape. Bond prices and yields move inversely to one another.
Those low yields elsewhere have been a symbol of a decade of futility for debt-laden European countries and a Japan that is still trying to break the back of deflation. However, that doesn’t necessarily translate into the same fate for the U.S.
“When we come out of this in six months, you’re going to have a lot of stimulus in the pipeline,” said Mike Collins, senior portfolio manager at PGIM Fixed Income. “I’m actually expecting a pretty significant recovery in the back half of the year because of the seasonality of this. Remember, we had a lot of economic momentum going into this.”
Indeed, Friday’s jobs report was just the latest data point to show the economy had solid momentum heading into the coronavirus scare, but to no avail.
The market stampede saw indiscriminate selling in stocks and huge buying in government bonds, trades that seemed to feed off each other and didn’t respond to the continuing spate of good economic news.
“It’s gotten to be kind of a circular trade,” said Kim Rupert, managing director of global fixed income analysis at Action Economics. “Equities are looking at the drop in the 10-year and the entire curve. That knocks equities lower and we get a flight to quality. It just ping-pongs back and forth between the two markets and drives everything lower.”
But Rupert also thinks the drop in yields, while signifying near-term panic, are signaling what could be a better path ahead.
The debate over lower yields
“Once we get through this, the amount of stimulus in the system could actually be a pretty huge positive in the second half of the year,” she said. “Maybe it’s a little counterproductive in the near term, just the whole fear trade knocking yields lower. But at this point, it’s so nebulous that a lot of the effects are difficult to see.”
To be sure, there’s doubt that lower rates will help deal with a slowdown emanating from a disease scare.
Lowering the cost of capital generally helps address demand-side issues. The Federal Reserve on Tuesday cut its benchmark rate by 50 basis points, something Rupert said was a waste of firepower. “They could have jawboned,” she said, referring to the ability to merely signal that rate cuts are coming and monitoring developments before acting.
Instead, the central bank acted, and now markets are expecting another 75 basis points of cuts as soon as this month’s Federal Open Market Committee meeting. Markets didn’t seem to take much comfort, though, from Tuesday’s move, and some investors are worried that the Fed risks having little policy ammunition left.
“Panicking because the Fed is running out of interest rate cuts ignores the reality of the last decade, when central banks around the world showed themselves open to taking unorthodox policy measures. It’s probably somewhat premature,” said Sonal Desai, chief investment officer at Franklin Templeton Fixed Income.
Desai also sees the economy recovering from the coronavirus scare, though she thinks it will require more than low interest rates.
In addition to the historically cheap borrowing levels, she also said some type of stimulus to help particularly sensitive areas of the economy, such as the restaurant industry, also would be appropriate.
“At this stage, rates this low will be very stimulative,” Desai said. “However, in the interim what you really need if you want to stimulate the economy is targeted help to prevent insolvencies and bankruptcies at a level the Fed can’t reach.”