For the first half of the year, the Federal Reserve held target interest rates steady at 2.25% to 2.5%, and during that time the yield curve flattened and at times inverted. Since then, the Federal Reserve lowered rates to 2% to 2.25% in July, then lowered them again in September taking its benchmark overnight lending rate to a target range of 1.75% to 2%.

This follows other Central Banks like the European Central Bank, who have taken rate reduction to the extreme by going to negative rates to stimulate their economies and the Bank of Japan who seems positioned to make a similar move. Bloomberg recently reported that 30% of all investment grade global bonds have a negative yield. According to Bloomberg, this translated into $17 trillion of bonds in a negative yield environment.

All of this has headlines focused on negative interest rates and whether the U.S. will see them in the coming years. And, if we do see negative rates, what does that mean for investors?

We’ve written about negative interest rates before, but typically interest rates reflect the amount a bank will pay you to hold your money. With negative interest rates, the opposite is true. Investors are paying the bond issuer to park their money in what many consider a “safe” investment versus the usual positive interest you earn on a bond.

What is driving investors to pay an issuer to hold their money? Political uncertainty, low inflation and trade disputes are some of the factors. There is a lot of fear out there.

What does this mean for investors? Will we get to negative interest rates in the U.S.? As of October 25, 2019, Research Affiliates’ asset class outlook is projecting a -0.6% return for U.S. bonds for the next 10 years (see figure 1 below).

Figure 1:

Source: Research Affiliates.

If that happens and you are an investor in a U.S. Balanced portfolio; 60% U.S. Stocks and 40% U.S. Bonds, the bond return will be a drag on the portfolio. The 40% of the portfolio allocated to bonds will have a small contribution-to-portfolio return. Couple that with a time frame where, according to Morningstar data as of September 30, 2019, the 10 year return on the S&P 500 is 13.24% and a U.S.-centric investor could expect muted returns in the future. What’s the next step for investors?

Ensure your portfolio is effectively diversified, and then stick with it. A well-diversified portfolio is one that goes beyond basic asset classes, and considers the underlying source of risk including market risk, company risk, inflation risk and—in this case—limits your exposure to interest rate risk.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Investing involves risk including loss of principal.

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.

Peter Smith

Peter Smith

Vice President, Financial Advisor

Peter joined the financial services industry following a successful career in sales, applying this experience to provide a high level of customer service to his clients. His focus is on guiding individuals through retirement by managing their cash flow, retirement lifestyle choices, charitable giving goals and estate planning objectives, ultimately working to anticipate risks and simplify their financial life.