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Income Investing

Negative Interest Rates? No Way, USA

Many bond pros say subzero interest rates are unlikely because they wouldn't help the U.S. economy and could damage it.

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Imagine you’re a saver who puts $1,000 in the bank and discovers when you go to withdraw your money that your deposit is worth only $990. Of course, no bank in its right mind would advertise a subzero yield. But Last National could slap a $10 exit fee on top of a no-payments policy and effectively impose a negative interest rate without calling it that. And I guarantee you that this kind of incongruity won’t cut both ways. No bank will accept $29,000 of payments on a $30,000 car loan and then extinguish the lien.

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In truth, when it comes to the savings of the average American, subzero interest rates are a nonissue. If necessary, you could fight back by sticking your cash in a safe-deposit box or finding an online bank that would pay you something. Avid competition for the public’s money in the U.S., as opposed to near-comatose demand in Europe and Japan, provides some assurance that yields here will stay in the black. Laurie Brignac, chief of money market funds at Invesco, says she doesn’t know of any money fund that has bought a debt instrument that sported a negative interest rate.

By contrast, European government bonds with maturities of up to one year regularly change hands at yields of –0.2% to –0.5%. And submerged yields aren’t limited to short-term debt. In March, the Bank of Japan sold 10-year bonds with a 0.10% interest coupon at a price above face value, resulting in a yield to maturity of –0.024%.

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For investors, the only way that owning bonds paying negative yields could work out is if deflation takes hold—or if someone else buys their bonds at a higher price (and at an even lower negative yield). At any rate, I am confident that you are not foolish enough to buy yield-free foreign bonds denominated in currencies, such as the euro, Swiss franc or yen, that could continue to lose value against the dollar.

But the prospect of negative yields in the U.S. just won’t go away. For example, the Federal Reserve is asking banks how negative rates would affect their businesses when it “stress-tests” them (alongside other questions about such perils as a deep recession and a spike in loan delinquencies). Even so, Fed chair Janet Yellen said during recent testimony before Congress that the Fed has no intention of introducing negative rates.

The downside. Many bond professionals say subzero interest rates are unlikely here because they wouldn’t help the U.S. economy and could actually damage it. Bob Andres, a former Merrill Lynch bond honcho who now runs his own investment firm, predicts that negative rates in the U.S. could lead to dire unintended consequences. The scariest scenario? Banks and insurance companies could find themselves having to pay interest to depositors or policyholders but be unable to earn anything on their own investments without taking substantial risks. Moreover, says Dan Heckman, a strategist for U.S. Bank, below-zero rates “would be telegraphing negativity to the financial markets and the general populace.”

And don’t forget that foreign investors view Uncle Sam as the go-to source for safe income. Consider that in early March, Treasury bonds with maturities of two, five and 10 years yielded 1.3 to 1.8 percentage points more than comparable Dutch, French and German government bonds. Those rate spreads have held steady for more than a year. If yields on Treasury bonds were to plunge below zero, the Europeans would likely force their own bond yields way, way, way into negative territory. The giant sucking sound likely to follow would be that of more European money crossing the pond. The dollar, already robust, could strengthen further. The risks of deflation and recession would rise. It would not be pretty.

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