USBAM's CIO, Jim Palmer, comments on the June 19^th FOMC meeting and considers how $13 trillion in negative-yielding overseas debt may be in play.

Jim Palmer, Chief Investment Officer

At its June 19^th meeting, the Federal Open Market Committee (FOMC) checked almost every box on the wish list of dovishness...short of actually cutting rates, that is. FOMC participants took the following near-easing actions:

• Adjusted the Dot Plot to signal a greater inclination to ease than seen in March's release
• Eliminated the rate-hike-associated word "patient" in reference to future policy adjustments
• Added language it "will act as appropriate to sustain the expansion" - which has become associated with rate cuts. Although, truth be told, changing "sustain expansion" to "sustain market asset prices" would have been more accurate, if not more honest.
• Reduced the long-run target rate to 2.50%. This is an underappreciated aspect to the FOMC release, as current target levels of 2.25% - 2.50% imply monetary policy is now neutral rather than accommodative as previously indicated. Lowering rates is an easier sell if you are moving off neutral rather than already accommodative policies. For what it's worth, this move was long overdue. We felt previous FOMC long-run targets of over 3.0% were misguided in this highly-leveraged global economy.

Bond traders reacted enthusiastically to the statement and Chairman Powell's market-friendly tone which drove interest rates down further. But there is another important factor to the sustained rally in U.S. Treasury bonds and the inverted yield curve: negative-yielding global debt.

As of mid-day Wednesday, countries with negative ten-year sovereign yields included Japan, Germany, Denmark, Switzerland, the Netherlands and Sweden. France occasionally joins the club but sported a lucrative 0.016% yield when I last looked. Data from the Barclays Global Aggregate Negative Yielding Debt Index suggest there is over $13 trillion in negative-yielding debt around the world.

In fact, virtually every major economy has a lower benchmark sovereign yield than the U.S.' 2.045%. At least ten-year government yields of Greece and Italy maintain a healthy spread over U.S. Treasuries of...uh...38 and 9 bps!?! Really? Score one for Mario Draghi. Anyway, it's no surprise there is intense demand for U.S. Treasuries given the alternatives investors face in other countries.

Understanding the policy efficacy of negative rates is difficult. I understand the logic: encourage savers to invest in riskier but, hopefully, more productive endeavors or face a slow erosion of buying power. To me the whole concept reeks of economic dysfunction, which is hardly an incentive to invest for the future. Holders of $13 trillion of negative yielding debt would seem to agree, preferring to use sovereigns and other higher-quality debt as a store of value until better opportunities arise - if they ever do. Mr. Trump and the markets want lower policy rates and the FOMC seems ready to oblige. I guess the hope is lower rates will paper over erratic trade policy and a lack of mettle to move out of crisis-era thinking.

Sources

Bloomberg

Federal Reserve Press Release and Economic Projection Materials, June 19, 2019

Federal Reserve Press Release and Economic Projection Materials, March 20, 2019