Consider the period in 2016 from late January to mid-June, just ahead of the U.K. vote to leave the European Union. In that five-month stretch, the benchmark 10-year yield fell from 2% to about 1.5%, providing a total return of 5.4%. Two-year Treasuries, by contrast, gained just 0.75% and bills (which admittedly had much lower rates at the time) earned only 0.25%, according to ICE Bank of America indexes.
That’s hardly an unrealistic scenario for the 10-year Treasury note. At their core, longer-term Treasuries are priced based on investor expectations for the path of short-term interest rates. The Fed raised them to a range of 2.25% to 2.5%, then had to screech to a halt. If they’re unlikely to get back to that level in the next decade, and in fact may stay substantially lower for an extended period of time, then a 2% 10-year yield looks like a bargain.
Granted, as Crise points out, it would only take 10-year yields rising to 2.23% to wipe out an entire year’s worth of interest. Still, it’s hard to see exactly what would push them in that direction, and, just as important, what would prevent a wave of dip buyers from swarming in and canceling out the move. For those concerned about market risk, there’s still a chance to buy into high-yielding certificates of deposit. Goldman Sachs Group Inc.’s Marcus, for instance, offers the opportunity to save for as long as six years with an annual percentage yield of 2.95%.
Money-market fund managers, meanwhile, still have time to get ahead of what appears to be the start of a period of Fed interest-rate reductions. They’re going to “want to have dry powder,” Mark Cabana, head of U.S. interest rate strategy at Bank of America, said at the symposium on Tuesday, referring to the ability to handle investor withdrawals.
The difficult question remains just how far the Fed will go in lowering interest rates. Chair Jerome Powell, in his press conference after the central bank’s latest decision, noted that “an ounce of prevention is worth a pound of cure” in this era of near-zero rates (he used the same phrase in a panel discussion on Tuesday). That could be taken to mean policy makers will act quickly and decisively, and then stop to see how that flows through to the economy and financial system. On the other hand, St. Louis Fed President James Bullard, who dissented at the June meeting in favor of lowering rates, said on Bloomberg TV on Tuesday that the current situation doesn’t call for a 50-basis-point cut.
In that case, money-market rates would be lower but hardly decimated. As Alex Roever, head of U.S. rates strategy at JPMorgan Chase & Co., noted to Bloomberg News’s Alex Harris, in 2007 and 2008, when the Fed swiftly took interest rates to near zero, “it wasn’t the fact that they had to cut rates” that damaged the industry, but that “the overall level of rates got so low.”
It has been a slow-but-steady comeback from the doldrums for money markets. Historically, according to Roever, the exodus tends to be the same, with outflows starting a year or two after the Fed begins to ease. At the same time, no prior period has had $13 trillion of negative-yielding debt worldwide. Just because there’s already been a rush toward higher yields in the U.S. doesn’t mean it can’t go further when interest-rate cuts begin.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.