The negative interest rate policies of the European Central Bank (ECB) and the Bank of Japan (BOJ) have created a Neverland in the global fixed-income markets. An 8/18 Bloomberg story reported:
“The world’s headlong dash to zero or negative interest rates just passed another milestone: Homebuyers in Denmark effectively are being paid to take out 10-year mortgages. Jyske Bank A/S, Denmark’s third-largest lender, announced in early August a mortgage rate of -0.5%, before fees. Nordea Bank Abp, meanwhile, is offering 30-year mortgages at annual interest of 0.5%, and 20-year loans at zero.”
A 7/29 story in The Washington Times reported:
“The latest estimates are that approximately 30 percent of the global government bond issues are now trading in negative territory. Last week, Swiss 50-year borrowing costs fell below zero percent, which means that Switzerland’s entire government bond market now trades with negative yields. Earlier in the month, Denmark became the country to have its entire yield curve turn negative.”
During 2018, when the 10-year U.S. Treasury bond yield was rising toward last year’s high of 3.24% on 11/8, there was much chatter about its going to 4%-5%. For example, on 8/4 at the Aspen Institute's 25th Annual Summer Celebration Gala, JP Morgan Chase (NYSE:JPM) Chief Jamie Dimon warned that the 10-year U.S. Treasury bond yield could go much higher:
“I think rates should be 4% today. You better be prepared to deal with rates 5% or higher—it's a higher probability than most people think.”
At the time, the bears worried about mounting federal deficits, resulting from the tax cuts at the beginning of the year, at the same time that the Fed was on track for more QT. In addition, there was mounting evidence that inflationary pressures were building, with some related to Trump’s tariffs.
In my 8/8/18 daily commentary, I wrote:
“So why isn’t the U.S. bond yield soaring? The bulls respond that trying to forecast the bond market using flow-of-funds supply-vs-demand analysis has never worked. It’s fairly obvious that U.S. bond yields are tethered to comparable German and Japanese yields, which are near zero, and are likely to remain there given the stated policies of both the ECB and BOJ to keep their official rates near zero for the foreseeable future.”
The tether has gotten tighter since last year’s peak in the U.S. bond yield on 11/8. Since then, the U.S. bond yield has dropped 164bps to 1.60% on Monday, while the comparable German and Japanese yields are down 111bps to -0.65% and 36bps to -0.23%, respectively.
Now consider the following related developments in the U.S. bond market:
(1) Tipping into negative territory. The 10-year TIPS yield dropped to zero on Monday, suggesting that the nominal yield reflects only inflation expectations with no real yield. The TIPS yield could be about to turn negative, as it did in 2012.
(2) Real rates and productivity. Why should the real bond yield be negative or even zero? The most widely accepted notion is that the real bond yield should be related to the growth rate in productivity, which is the economy’s real return, arguably. The correlation between the two—using averages over five-year time periods—is not compelling, though. In any event, productivity growth has been turning up over the past few years. Productivity has been growing faster in the U.S. than in the other G7 economies.
(3) Demography is destiny. The geriatric trend in global demographic profiles does support a case for negative nominal and real interest rates if the trend leads to a combination of slow growth and deflation. That’s if deflation reduces the value of assets purchased today with debt. Negative interest rates on that debt might reflect the voluntary self-extinction of the human race attributable to the collapse of fertility rates around the world. Dwindling populations, particularly of younger people, will put downward pressure on real asset prices, because there will be less demand for the goods and services they provide in the future.