Tom Sedoric and Casey Snyder

The headlines of late have been filled with impeachment scenarios in the United States and incompetent leadership in Great Britain as the Brexit countdown to real economic consequences winds down.

We have been watching two trends mostly hidden in the headline shadows and for good reason. Few people want to talk about the runaway national debt train, and no one signs up for seminars on negative interest rates. Yet both unmentionables could have a lasting impact across the generational spectrum – from the tens of thousands of baby boomers who retire daily to millennials who are in their prime earning years.

The national federal debt has reached $22.5 trillion (and counting) or more than 106 percent (and growing) of GDP. A recent CNBC story went one step further and put the national debt in a greater context: namely, that all debt – public debt like bonds and financial debt such as Social security, Medicare and public pensions – represents as much as 1,900 percent of GDP into the foreseeable future, according to a recent Wall Street study. 

“We are quickly approaching a situation where we have dug ourselves a debt hole which is going to have profoundly negative effects on the economy for probably decades going forward,” said Maya MacGuineas in the story. MacGuineas is president of the Committee for a Responsible Federal Budget, a bipartisan committee of legislators, business leaders and economists that counts former Federal Reserve Chairs Paul Volcker and Janet Yellen among its members.

This is why we educate our clients on the likelihood, if not certainty, of higher taxes in the future. The reality of negative interest rates represents another factor that would usually only make sense in a comedy sketch. Imagine if George Bailey, the head of Bailey Savings & Loan in the iconic holiday movie “It’s a Wonderful Life”, had customers who lost money just for the privilege of parking their money in his institution. In other words, Bailey paid his customers a negative interest rate.

In a runabout way, it’s happening with the new global phenomenon of negative interest rates which could reach these shores. There are colliding factors at play such as the recent collapse in bond yields, the Federal Reserve’s quarter point cut to the Fed Funds rate, and surging bond prices (remembering that prices trade inverse to yields). the world’s largest economy may eventually join Germany, Japan, France, the Netherlands, Switzerland and a number of other nations and expand on the already 14 trillion dollars of bonds currently trading with negative yields. Among many reasons this is a result of sustained, ever lower central bank interest rates and governmental pressure on large institutional investors such as insurance companies to play a role few would desire.

In a recent Financial Times essay, curmudgeon English strategist Sir John Redwood wondered why more couldn’t see the danger. “I cannot bring myself to buy sovereign bonds offering negative yields,” Redwood wrote.

It’s a crazy world where people will pay the German or Japanese government for the pleasure of lending to them. Presumably investors who buy bonds offering a guaranteed loss if you hold them to redemption do so because they expect to sell them to someone who pays an even more ludicrous price well before the bond is repaid.

Ludicrous or not, the prospect of negative interest rates is unchartered territory for the American economy. Logic would tell us that paying the bank to hold your money rather than receiving interest will be disruptive to markets, investor psychology, and currency values. More importantly, how might this impact the portfolios of our clients? Just think of an insurance policy where the ability to pay the claim was dependent on normal bond yields – or a pensioner whose fund had assumed mid-single digit returns on fixed income. In a sane economic world, banks stay solvent when interest rates are normal. What happens when they are not?

We don’t know. The new normal is fluid, defies precise definition and millions of investors could be caught unaware. A stampede from the security of bond yields into the equity market could lead to more volatility. We do believe the era of double-digit annual returns is unlikely to return anytime soon and a reconfiguration of long-term expectations and planning is at hand. 

This information has been obtained from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed. The views expressed are those of Tom Sedoric – Partner, Executive Managing Director and Wealth Manager and D. Casey Snyder, CFP® - Partner, Senior Vice President and Wealth Manager and are not necessarily those of Raymond James. Steward Partners Global Advisory LLC and The Sedoric Group maintain a separate professional business relationship with, and our registered professionals offer securities through, Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment advisory services offered through Steward Partners Investment Advisory LLC. 2985754