Second, yields may become even more negative, which allows for profit potential for those willing to sell before maturity. This scenario could happen, as the European Central Bank (ECB) is struggling to find enough bonds to buy in order to meet its 60 billion euro/month quantitative easing (QE) quota.
So, given Europe’s sluggish growth and low inflation, and the fact that European QE will continue for at least another 18-months, what does a persistent regime of negative yield mean for investors? Here are three implications.
- Lower rates on U.S. Treasuries. While low European rates don’t represent a ceiling for U.S. yields, they are suppressing U.S. rates. It’s hard to reconcile a sub-2% U.S. 10-year yield with the current strength in the U.S. labor market. Part of the reason U.S. yields remain this low, even as the economy recovers and the Federal Reserve (Fed) prepares to raise rates, is that U.S. bonds look attractive to investors in Europe and Japan. The relative value in U.S. bonds is leading to cross-border flows that are driving U.S bond prices higher and yields lower.
- A stronger dollar. Attractive U.S. rates, and the accompanying capital flows, are one reason the dollar is, while off its highs, still up over 8% year-to-date.
- Outperformance for European yield plays. I’m cautious of U.S. income plays, but in an environment of negative yield, income-producing stocks in Europe have a natural edge. Plus, their valuations are less stretched.
The bottom line: The last six years have involved a non-stop guessing game of how low interest rates would go. Most of us assumed that there was a lower bound. It turns out we were wrong.
Source: Bloomberg
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog and you can find more of his posts here.
