The Federal Reserve earlier made its first emergency rate cut since the financial crisis. It cut its benchmark rate by 50 basis points to 1%, the lowest since June 2017.
This is what lower Treasury yields mean:
WHY ARE TREASURY YIELDS FALLING?
Treasury yields are falling as investors anticipate a weak global economic growth outlook, which has been worsened by the coronavirus. Lower yields also reflect benign inflation as the Federal Reserve struggles to achieve its target of 2% price increases.
China is a significant contributor to global growth. When it closed factories it slowed its economy, and in some cases left international firms struggling for parts. A similar response in other countries would be an additional drag on growth.
Many sectors including travel, retail and hospitality are likely to see slowdowns as people respond to the virus by spending less time in crowded areas.
Yields have tumbled as investors pile into the safe-haven bonds to protect against losses in riskier asset such as stocks and corporate bonds. The move down in yields has also prompted investors to hedge mortgage holdings, which adds to the decline.
Still, U.S. Treasuries remain relatively attractive as they pay higher yields than comparable bonds in Europe and Japan, many of which trade in negative territory. U.S. 10-year Treasuries US10YT=RR currently yield 0.95%, compared to negative 0.64% in Germany DE10YT=RR and negative 0.11% in Japan JP10YT=RR.
FEDERAL RESERVE MAKES EMERGENCY RATE CUT
Falling yields put pressure on the Federal Reserve to respond. The U.S. central bank on Tuesday cut interest rates in an emergency move meant to loosen financial conditions and protect the economy from the impact of the coronavirus.
Tight economic conditions make businesses less likely to invest in growing their firms, which harms economic growth. Looser economic conditions can stimulate growth by encouraging firms to borrow and spend.
By cutting rates the Federal Reserve also signals that it is willing to act to maintain the economic expansion, which gives give companies more confidence to invest and hire.
Interest rate futures traders pricing in a 58% probability of a further 25 basis point cut in April, according to the CME Group’s FedWatch Tool.
WHO BENEFITS FROM LOWER RATES?
The biggest beneficiary of lower rates is the U.S. government, which has been financing its growing deficits with public debt.
The non-partisan Congressional Budget Office expects U.S. federal debt held by the public to grow to $31.4 trillion by 2030, from $17.9 trillion this year. The higher the rate paid on the debt, the more pressure it puts on government spending and the more it weighs on gross domestic product.
Companies also benefit as they can borrow more cheaply and invest in growing their business, which boosts growth and employment. This investment, and greater liquidity from looser monetary conditions, typically boosts stock prices.
Lower interest rates feed through to cheaper mortgages, which can lure new home buyers. They also allow existing home owners to refinance loans at lower rates, which reduces their debt obligation. Consumers can borrow at cheaper rates to finance auto purchases or other large purchases.
WHO IS HURT FROM LOWER RATES?
Savers, primarily. As returns from savings accounts fall, pensioners and others that rely on a fixed income may be pushed to invest in riskier assets such as stocks or corporate bonds to make ends meet. This puts them at greater risk of investment losses.
People trying to enter the home market can benefit from lower rates, but also suffer from higher home prices that result from cheaper loans. This requires them to save more for a deposit. They are also more exposed to losses if rates change direction and move higher, which typically leads house prices to fall.
Lower rates also give the Federal Reserve less ammunition to fight a recession down the road if it emerges.
