VP, U.S. Rates Strategy
BMO Capital Markets
Chief Investment Strategist
State Street Global Advisors
Fixed income markets have been a wild ride this year. A record $15 trillion of global bonds have negative interest rates, according to Bloomberg, and even U.S. yields are tumbling to jaw-droppingly low levels. Could the U.S. join Europe and Japan with negative interest rates? Will the Federal Reserve cut rates only a few times, or more deeply than that? And how should investors position their fixed income portfolios in this fast-moving environment?
Those are a few of the questions ETF.com raised with four fixed income experts. Below is part one, which features answers from Michael Arone, chief investment strategist for State Street Global Advisors, and Jon Hill, vice president of U.S. rates strategy for BMO Capital Markets. Read part two here.
ETF.com: The Fed hinted that its last rate cut was more of a midcycle adjustment rather than the start of a long rate-cutting cycle. The market doesn’t believe that. What do you think?
Jon Hill: The FOMC [Federal Open Market Committee] clearly desires to only implement a series of midcycle adjustments similar to the late-90s period. I’m skeptical they’ll be able to pull this off, as the overseas growth prospects look formidable. The fact that five- and 10-year breakevens are very low, despite market expectations for a cut that reflects the degree of skepticism that the Fed—try as they might—will be able to avert a global recession.
Michael Arone: Rate cuts are like potato chips—you can’t have just one. The Fed is likely to cut rates again at their next meeting Sept. 17 and 18. President Trump, market volatility, escalating trade tensions and weak economic data are putting additional pressure on the Fed to act faster and more aggressively. The probability is rising of an inter-meeting cut and/or a 50 basis points reduction in the target fed funds rate. Chances are growing the Fed will lower rates for a third time in 2019 later this year, perhaps in December.
ETF.com: There’s growing chatter about interest rates in the U.S. hitting zero or even going negative like they are in Europe. Is that realistic, or absurd?
Arone: Never say never, but the likelihood that U.S. rates go to zero or even negative is very low. Conditions would have to worsen materially for that to happen. Taking a simple average of the first two quarters’ U.S. GDP figures indicates the economy is growing by about 2.6%. The unemployment rate is at a 50-year low. Several inflation measures are hovering near the 2% target. U.S. stocks reached all-time highs on July 26. This backdrop hardly suggests the U.S. economy is hurdling toward collapse.
Hill: It’s certainly possible, though that would be rather extreme. I don’t anticipate the Fed to push overnight rates negative. Rather, we’d anticipate another QE [quantitative easing] program if/when the Fed has to return the target range to the effective lower bound. In that world, we’d just expect a very low and flat curve, and 10-year yields possibly below 1% depending on the macro backdrop. While far from my base case, it is something investors would be wise to consider as a low-likelihood adverse scenario.