Pimco Says Case for Subzero Real Yields Holds Despite Inflation
(Bloomberg) -- The consensus on Wall Street has reached a roar: U.S. interest rates have nowhere to go but up.
Virtually drowned out in the noise is the voice of Pacific Investment Management Co.’s Joachim Fels, who in 2019 predicted that U.S. rates could even go negative as people save more and enjoy longer retirements. His case helped convince former Federal Reserve Chair Alan Greenspan that Treasury yields could dip below zero.
Despite raging inflation, looming Fed hikes and rising long-term Treasury yields, Fels says his theory is alive and well. “This is not the beginning of a new paradigm or a world of permanently higher interest rates,” Fels, Pimco’s global economic advisor, said in an interview.
He’s not predicting that nominal Treasury yields will turn negative, given that central banks like the Fed are getting hawkish to fight the steepest surge in consumer prices since the early 1980s. But he’s says the rate-suppressing catalysts that powered his argument have only gotten stronger and explain why real yields -- or those adjusted for inflation -- are below zero and have good reason to stay there.
“What has not changed has been the fundamental global savings glut. That helps to explain why people are willing to invest at low real -- or even negative -- real interest rates,” Fels said in the interview. “The pandemic was a shock, and has increased the desire for people to save more for precautionary reasons. And this contributes to depressing real interest rates. So that fundamental force has not changed, and if anything it has become stronger.”
Overall yields have jumped sharply this year as the world’s central banks move to withdraw pandemic-era stimulus, with those on 10-year Treasuries climbing above 2% from as little as 0.31% in 2020.
Traders expect about seven quarter-point Fed rate hikes this year as the bank moves to get inflation under control. In Europe, traders are wagering the European Central Bank will raise its key deposit rate to zero by year-end from minus 0.5% currently. The Bank of England has already raised rates two times. At the same time, the global pile of negative-yielding debt has shrunk substantially to about $4 trillion from more than $18 trillion in late 2020 as rates rise overseas.
Yet U.S. real yields have been nearly consistently negative, sometime deeply so, since the pandemic took hold in in the U.S. in March 2020.
The 10-year yield on inflation-adjusted Treasuries, known as TIPs, remains below zero at negative 0.49%, though that’s down from last year’s low of negative 1.2%, reflecting the rise in yields and drop in inflation-expectations in the wake of the Fed’s new resolve to tighten policy. Thirty-year TIPS yields climbed above zero earlier this month for the first time since June.
But Fels says his theory nonetheless remains intact, since it rests on a much deeper shift than the swings in monetary policy.
As he explained in 2019, economic theory has generally assumed that investors will always demand a positive return for parting with their money instead of spending it right away. That made sense, he wrote, when many died before retirement and struggled day to day. But now people can expect longer retirements and are saving accordingly.
Moreover, the sharp drop in yields late Friday underscored that Treasuries haven’t lost their appeal as the go-to haven, with investors flooding in after U.S. officials warned that Russia soon could take military action against Ukraine.
“Clearly, we are in a different nominal rate environment, at least for now, with much higher inflation,” he said. “But the jury is still out on whether this is really a permanent change or whether this is something that has to do with the supply constraints that appeared during the pandemic, the shift from demand for service to the demand for goods, and also partly related to a huge but temporary fiscal stimulus that is now ending.”
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