Monthly Investment Outlook - What Investors Should Know About Negative Yields

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What Investors Should Know About Negative Yields

Wells Fargo Investment Institute - November 2019

Presenter: George Rusnak, CFA, Co-Head of Global Fixed Income Strategy, Wells Fargo Investment Institute

Transcript: What Investors Should Know About Negative Yields

Title graphic: Negative yield global debt is increasing

This year, the amount of global debt outstanding with negative yields has been increasing at an alarming rate. In late August, the amount of negative yielding debt outstanding peaked at $17 trillion, which is far greater than the $8.3 trillion at the beginning of the year and larger than the previous high of $12 trillion experienced in late July 2016.

Chart: Negative yielding debt has been steadily increasing this year. (Source: Bloomberg, October 16, 2019. Chart shows negative yielding debt in the Bloomberg Barclays Global Aggregate Index in U.S. dollars. Last price as of 10/16/19.)

We believe this figure is increasing due to economic weakness overseas and monetary policy that fosters a negative interest rate environment. So, what does this trend mean for investors?

Title graphic: The impacts of negative rates

Although some central banks have embraced the concept that negative rates promote growth by incenting banks to lend, and individuals to spend cash, we believe the results have been mixed. Specifically, countries that have adopted negative rates—Japan, for example—have actually seen their growth and inflation rates continue to decline. Additionally, negative short-term rates depress other rates along the yield curve and globally, which presents a challenge for investors struggling to meet their income needs. Finally, some European banks have recently indicated that they will be raising fees to offset the cost they incur by not passing negative rates on to clients. In our view, negative rates haven’t proven to be as effective of a monetary policy tool as first hoped, and we believe there are negative consequences to moving further down this path.

Will negative rates come to the U.S.? Given the questionable effectiveness of negative rates and the potential for damaging impacts to other parts of the economy, we believe it’s unlikely the U.S. will move toward negative rates. That said, we can’t completely eliminate the possibility. Current Federal Reserve (Fed) officials, and even the Fed chair, have spoken out against the challenges that negative rates pose to the economy. So, what are the Fed’s alternatives as short-term rates approach zero? We see at least three alternatives: 1.) Continue to offer optimistic forward guidance, 2.) re-examine quantitative easing to try to force liquidity into the market, and 3.) increase pressure on government officials to implement fiscal stimulus as monetary policy approaches the limits of what it can do to help grow the economy.

Title graphic: Investor implications

As yields decline due to an increasing negative interest rate environment, investors’ risk tolerances may be tested. They may seek out yield from riskier and riskier investments. However, we believe investors should consider reducing their credit risk exposure and take a more neutral view on their interest rate risk. We believe that sectors like investment-grade corporates, preferreds, and mortgage-backed securities offer opportunities for additional yield. Additionally, we recommend investors consider diversifying their income streams across bonds, stocks, real assets, and alternatives where possible.