Why Interest Rates Could Stay Lower Longer Than You Think – Visionary Wealth Advisors

Why Interest Rates Could Stay Lower Longer Than You Think

John Fischer, CFA®, CFP® | Chief Investment Officer
July 6, 2020

When investors are asking the question of what would happen if interest rates went negative, it’s a reflection of just how far interest rates have fallen. At the beginning of 2020, the 10 year treasury yield was 1.80%. Six months later in the midst of a global pandemic, the 10 year treasury yield rests at an astonishing 0.70%. You might have heard (or might even be saying yourself) that bond yields have to go dramatically higher or owning bonds is dangerous. Let’s look at why that perspective may not be as valid as one might think and why bonds still deserve to be a vital component of investor portfolios.

  • Trip back in time – Looking back at 10 year treasury rates since 1870, it’s quite surprising how often interest rates have been low over the past century and a half. The median 10 year interest rate since 1870 is 3.83% and that includes the dramatic outlier period of the late 1970s and 80s.1 The Great Recession of 2008 and the Covid pandemic have been the two largest economic shocks since the Great Depression. What happened to interest rates after the Great Depression? It took more than 20 years for the 10 year to rise above 3% again. Lower interest rates for longer after a cratering of the economy would not be unprecedented.
  • What’s the catalyst for dramatically higher interest rates? The two biggest drivers of interest rates are changes to expectations for inflation and economic growth. Despite a near 11 year economic expansion that ended in February, inflation consistently ran below 2% thanks in part to deflationary advances in technology (i.e. Amazon). Meanwhile, we haven’t seen GDP growth at or above 3% since 2005. Both inflation and economic growth have remained stubbornly low over the past decade, suggesting a catalyst for dramatically higher interest rates may be lacking.
  • Myth: Interest rates can’t go lower – We’ve heard this song before. In December 2018, 10 Wall Street strategists forecasted the yield of the 10 year treasury note at the end of 2019. The 10 predictions ranged from a low of 2.75% to a high of 3.60%.2 At the time of the predictions, the 10 year yield was 2.82%. The 10 year note finished 2019 yielding 1.88%. All 10 Wall Street experts were not only wrong about the direction of rates but each and every analyst’s prediction was off by almost 100 basis points or 1%. If you think interest rates can’t go lower, one only has to take a swim across either ocean to Japan, the UK, Germany, or Switzerland for evidence that rates can indeed go lower.
  • All this Fed spending is going to cause inflation – What makes you so sure? Looking back at financial articles and blogs from the beginning of the last decade would remind us of the many experts who predicted that the Fed’s quantitative easing policy and massive stimulus to stop the economic bleeding from the Great Recession would cause runaway inflation. Despite the trillions of dollars spent, core inflation hasn’t broken 2.5% since the Great Recession. In the 1930s, the Great Depression also saw massive government spending in the form of FDR’s New Deal (and later World War II) and yet 10 year treasury rates stayed below 3% until the mid-1950s. There’s plenty of historical precedent to illustrate that high inflation following large government spending is far from a foregone conclusion, despite the large increase in total U.S. debt.
  •  Be careful betting against the Fed – Since the Great Recession, the Fed has maintained a bond buying program, called quantitative easing, whereby they purchased trillions of dollars of bonds in the marketplace to keep interest rates lower to support the consumers and businesses that make up the U.S. economy. That program has ramped up its amount of bond buying in recent months to provide stronger support of the economy during the current crisis. The Fed’s bond buying is one more downward pressure on the overall level of interest rates.

Rates won’t stay this low forever but investors may be mistaken if they think rates are likely to move dramatically higher. Investors shouldn’t forget that they can make money in bonds even when interest rates rise if they do so in a slow, controlled manner. Finally, the most important takeaway shouldn’t be where interest rates will go and how fast (no one knows) but that the importance of owning bonds in a diversified portfolio should not be diminished in the current low rate environment. Investors own high quality bonds for income, principal protection, and as a ballast for their portfolios when stocks decline. The declining level of income from bonds recently doesn’t change their ability to protect principal and serve as the brakes for a balanced portfolio when the stock market declines, as 2020 has so eloquently reminded us.

Source: 1 https://www.multpl.com/10-year-treasury-rate, 2 Barron’s

Disclosure: The opinions voiced in this material are for general information only and should not be construed as personalized investment advice, including the recommendation to engage in a particular investment strategy. Past performances referenced within may not be indicative of future results and may have been impacted by events and economic conditions that will not occur or prevail in the future. No investment strategy can guarantee a profit or protect against a loss in periods of declining values. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy, including those undertaken or recommended by Visionary Wealth Advisors, will be profitable or equal any historical performance level(s).