Another New Normal?

A few weeks ago, I wrote about negative interest yields on bonds as long as ten years in Europe. (Click here for a refresher)

The main point that I was trying to deliver (other than that it’s a crazy mixed up world) was that we really can’t say where yields in the US are going with much confidence.

While that’s not a new argument coming from me, the idea that rates could go below zero is a break in my old assumptions.

For a long time, I believed, as I think most people did, that interest rates had a ‘zero bound,’ meaning that the yield can’t go below zero, which created an asymmetric risk profile of limited upside (prices go up when yields go down and if they can’t go below zero, the price is capped) and unlimited downside (since yields could go to 1,000 percent or higher in theory).

A recent article from Nouriel Roubini, an economist who was known as Dr. Doom in the 2008 financial crisis for saying that the US financial system was insolvent, made the case that negative interest rates could stick around for a while. (Click here for his article)

One of the facts he included that really blew my mind was that about $3 trillion of assets in the Eurozone now have a negative yield. After my article, a loyal reader asked why you wouldn’t just put money in a hole in your back yard rather than lose money at the bank.

Although I didn’t say it, my first thought was that you couldn’t dig a hole deep enough for all of the institutional money that needs to be invested. That might work for a small time saver, but a government pension couldn’t even get the physical cash to bury.

Roubini makes a point that I wish I had made, which is that negative interest rates may lead savers to save less and spend more, which is exactly the idea behind negative interest rates at the central bank level.

Central bankers don’t control much beyond the short end of the curve, so that doesn’t explain why Swiss 10-year bonds have negative yields, but Roubini is still right.

He adds that if we are in a world of secular stagnation thanks to slow growth and high debt, negative interest rates could be the new normal.

Of course, Roubini, doesn’t know what the new normal is (just ask Bill Gross about his new normal five years ago that called for low equity returns), but he’s right that it’s a possibility that no one really imagined until recently.