We’ve been hearing that interest rates are “historically low” for some time now. But how historic are we talking? Even Thomas Jefferson would have been surprised to see the most respected debt issuer in the world paying just 1.47% on ten-year notes — the lowest in the history of the United States.
Record interest rates — high or low — are generally not a good thing. When they are super high, as they were in the early 1980s, or super low as they are now, something is wrong somewhere. In the early 1980s, the problem was inflation. Now the problem is the weak state of the jobs market in the U.S. and economic chaos in Europe — especially Greece and Spain, where crushing debt, high unemployment rates, and low productivity are threatening the banking systems. When investors are worried about the economy in or financial stability of their homelands, they gather up their Euros and dollars and park them in the safest place they can find. That would be the U.S. Treasury market.
The newest impetus in the so-called “flight to quality”: The Bureau of Labor Statistics report Friday morning revealing that nonfarm jobs grew my a meager 69,000 — well below expectations. The report tops a series of weak economic releases from around the world, prompting investors to move their investments from assets that do well in strong economies — like stocks — and pouring them into safe havens. As a result, the Dow Jones Industrial Average has completely wiped out its gains this year and U.S. Treasuries yields are setting new lows as investors drive up the prices on the securities.
But the race to safety began earlier this year with overseas investors, especially in the most wounded European economies. Greeks have been on the cutting edge, fearing they may wake up one morning and find all their Euros transformed into drachmas — which could easily cut their wealth in half. Bloomberg terminals have already created a trading screen for the Greek Drachma. Spaniards are now going the Grecian route as well, withdrawing assets –again, just in case. Currency devaluation is an old tool in the sovereign debt tool box. It wasn’t that long ago — in 2001 – that Argentina shut down the banks for a week. When the Argentines came back to their local branches, their money was all there but deeply devalued.
And so the fear-of-the-unknown trade is spreading across the continent, driving investors to U.S. Treasuries. These investors don’t even care about yield, says James Bianco, president of Bianco Research, a Chicago firm that keeps tabs on where bonds rates have been and where they are going. “They care about the return of their money.” So what if the U.S. lost its vaunted triple-A rating last August. And that fiscal cliff we keep hearing about? It’s a mole hill compared to what Greece and Spain face. And though U.S. growth may be weak, at least it exists. Praise the full faith and credit of Uncle Sam. Or, as the wags on Wall Street would say, we are the cleanest dirty shirt.
The U.S. is not the only safe haven, but it is the primes inter pares because it is the largest and deepest market in the world. Still, nervous Europeans are also buying bonds issued by the German and Swiss governments. Yields have actually turned negative on the Swiss five-year note, which means that investors are paying the Swiss for the privilege of lending money to a country that did not adopt the Euro. It’s not so unusual these days for short-term bills to produce negative returns, but a five-year note? That’s a record, says Bianco. Anxious Europeans are also swapping Euros for U.S. dollars or Swiss francs.
In theory, the super-low rates here should be good for the economy, encouraging people to borrow money to start or expand businesses, or to buy homes and new cars. But the Federal Reserve has kept rates unusually low ever since the economic crisis began in 2008. That means the current drop in rates is unlikely to do much more for the economy. (If you haven’t refinanced by now, marginally lower rates are unlikely to push you to do it now.) Indeed, the New York Fed reports that household debt continues to decline, falling 0.9% in the first quarter from the previous quarter to $11.44 trillion.
Low rates also aren’t giving businesses the courage they need to take on more employees — the key impediment to a robust recovery. And they’ve been a killer for anyone living on a fixed-income. They’ve also created an incredibly precarious financial system, says Bill Gross, head of Pimco, the world’s largest bond fund manager. In his monthly letter, published Thursday, Gross bemoans the lower rates that have now attached themselves to sovereign debt that is only growing riskier and riskier. Just five years ago, he writes, no one could have imagined higher prices for debt that was declining in quality. The situation can’t continue: Eventually, major Treasury investors like China or Japan will hunt elsewhere to invest their excess dollars — most likely hard assets like land or commodities.
But for now, Europe’s greater problems and weakness in the jobs market here are keeping prices in the U.S. Treasury market unusually high. Many believe that prices could head higher still. Hard to believe. Thomas Jefferson would have found that almost as astonishing as the mountain of debt the world now struggles to throw off.