Fixed income markets in much of the developed world are sailing in uncharted waters. Outside the United States, a large portion of the developed fixed income market is trading at negative interest rates (see Exhibit). In the United States, the 10-year US Treasury is trading at an extremely low yield—one that has historically been consistent with conditions of severe US economic distress.
Investors must understand the factors contributing to this extreme interest rate environment in order to safely navigate these uncharted waters—that is, to preserve capital and maintain enough liquidity to meet cash obligations. Does the low interest rate environment reflect underlying weakness in US economic fundamentals? If not, why are rates so low? And regardless of the answer to those two questions, how should investors position their portfolios in order to maintain the margin of safety expected from a US fixed income allocation?
Exhibit: Negative Yielding Debt Went from $0 in 2013 to More Than $15 Trillion in 2019
As of 30 September 2019
Source: Bloomberg
A Sea of Calm
Economically, the United States remains a sea of calm. Unemployment is at historically low levels. The headline U-3 unemployment rate is at a multi-decade low of 3.7%. Corporate leverage has grown, but so have corporate earnings. As a result, default rates are running below their historic long-term average. Contrary to the pessimism implied by US rates, default forecasts from the likes of JPMorgan and Moody’s remain low and lending conditions are easy, according to the Federal Reserve’s index of financial conditions. Nominal GDP growth and inflation remain positive, and we expect trends in both measures to remain steady.
Smooth sailing or all hands on deck? Read the full Lazard Insights paper.
The preceding is an excerpt of Why So Much Negativity?
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Originally published on 18 November 2019.
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