Britain’s vote to leave the European Union has sent investors once again to the perceived safety of bonds, renewing a question that has befuddled markets since the 2008 financial crisis: How low can yields go?
With 30-year and 10-year U.S. Treasury bonds touching record lows Friday and negative interest rates on bonds from Germany, Japan and elsewhere, analysts admitted the bottom probably still hasn’t been reached. That has produced a windfall for people who invested in them either by direct purchases or through bond funds and target date mutual funds that contain a mix of stocks and bonds.
“Until we get there, the answer is you can see rates go lower,” said Bob Smith, president of asset-management firm Sage Advisory Services.
The yield for benchmark 10-year U.S. Treasury bonds, which moves in the opposite direction as price, rebounded Friday to 1.45 percent, after briefly dipping to 1.37 percent – below the previous record low hit in 2012. That remained well below the 1.75 percent yield just before the British referendum.
“I think we just have to accept this is a low-yield world until further notice,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research.
She wouldn’t be surprised if the 10-year yield dropped as low as 1 percent in a worst-case scenario in the coming months.
“Everybody’s convinced they have to go up and then they go lower,” Jones said.
Bonds from the U.S. Treasury and the governments of other major industrialized nations are viewed as safer investments because they have the backing of those nations. The same goes, to a lesser degree, for bonds issued by healthy corporations.
During times of uncertainty, demand for bonds rises. That means issuers can offer lower rates at bond auctions. And the lower the interest rate on new bonds, the higher the value to investors of older bonds that pay higher rates.
So investors make more money on the sale of bonds if the rates go down and lose money on bond sales if the rates increase.
Since the 2008 financial crisis, the yield on 10-year U.S. Treasury bonds has trended down from about 4 percent. Analysts frequently have thought the yields had hit bottom, only to see a new crisis – domestic or global – push them lower.
This was poised to be the year that yields started heading up after Federal Reserve policymakers increased their benchmark short-term interest rate in December and signaled that four more increases were coming in 2016.The Fed had pushed the rate to near zero in 2008 and kept it there for seven years to try to boost economic growth, creating an extreme low-rate environment.
Although the federal funds rate doesn’t directly affect long-term bonds, it has an indirect influence in part because it signals the central bank’s view of the U.S. economy.
Concerns about slowing global growth this winter led the Fed to reduce its forecast for rate increases this year by half. And many analysts now believe the British vote has pushed off another increase until at least the fall.
“There’s no doubt they will use this to keep rates lower for longer than any of us imagined six months ago,” said Joe Duran, chief executive of United Capital, a Newport Beach firm that manages $16 billion in assets.
“I have been wrong for a long time because I assumed that when we were at 3.5 (percent), that was the bottom,” Duran said. Now he thinks the 10-year Treasury bond could go down to 1.25 percent or lower. The long-thought bottom of zero percent no longer exists, Duran said.
Demand has been so high for the safety of government bonds that investors are willing to pay to hold the debt of some nations, through negative interest rates.
Rates have dropped below zero for some bonds from Germany, Japan, Switzerland and France. And the uncertainty caused by the British EU vote has pushed more money in that direction.
“We’re in an uncharted-territory world where you have negative interest rates,” Duran said.
Fitch Ratings said Wednesday that $11.7 trillion was now invested in bonds with negative yields, up from $11.3 trillion at the end of last month.
Negative rates make the low-yield 10-year U.S. Treasury bond more attractive, Smith said.
“We are the high-yield alternative in the government bond market,” he said.