As yields on U.S. debt continue to fall, Allianz Chief Economic Adviser Mohamed El-Erian says he would sound the alarm if treasury yields dip into negative territory.
“If we do I’m going to be really worried because negative yields in the U.S., the world’s biggest financial market, will break things,” El-Erian told Yahoo Finance’s On The Move on Wednesday. “The system is not built to operate with negative yields.”
El-Erian’s comments come as investors worry about the implications of the yield curve inverting for the first time since 2007.
Early on Wednesday morning, the yield on the U.S. 10-year Treasury tipped one basis point below the yield on the U.S. 2-year Treasury for a brief moment. The spread between these two closely watched debt instruments has been a reliable indicator of recessions in the past; the 10-year fell below the 2-year ahead of each of the last seven recessions dating back to 1969.
The 10-year Treasury yield was hovering around 1.59% as of Wednesday afternoon, a significant dip from 3.19% in November 2018.
Former Federal Reserve Chairman Alan Greenspan told Bloomberg on Tuesday that as bond yields fall there will be “no barrier to Treasury yields going below zero.”
But El-Erian worried that negative yields would “take away the provision of long-term protection products,” adding that it could lead to a rethink of the banking industry, retirement plans, and life insurance. Currently, U.S. bonds have positive yields, which reward investors for holding onto government debt (perceived to be a relatively risk-free asset). If bonds had negative yields, it would cost investors to hold onto those safe assets.
“Negative yields have huge implications for how the economy operates,” El-Erian said.
On the inverting yield curve, El-Erian said it should not be “treated as a traditional signal” of a recession, arguing that it is “distorted” by negative bond yield rates in countries abroad (i.e. Germany, Japan) in addition to market pressures on Fed actions.
But he warned that the Federal Reserve should still be mindful about handling rate policy with bond rates where they are, worrying that moving too quickly to lower rates would guarantee negative yields.
“The [European Central Bank] made that mistake and they can’t get out of it,” El-Erian said. “And the Fed has to be careful not to make the same mistake.”
As of Wednesday afternoon in New York, the 10-year German bund yield was at -0.657% and the French 10-year bond yield was at -0.3715%.
Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.