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Kelly Evans: The major dangers of low rates

CNBC's Kelly Evans

A few people have been asking me why, as the 10-year Treasury yield continues to plunge, I am so upset about it. After all, aren't low rates a good thing?  

No. Not right now. Here's why:

(a) The speed and size of this plunge is terrifying. We had never gone below 1.3% until last week, and we're now sitting at 0.67% as I type this. That has all the hallmarks of a bubble or "buying panic," as Mike Santoli put it last week. Only two things can happen now. Either we are going permanently lower in rates--joining the "zombie" financial systems of Japan and Europe--or we unwind a la the "taper tantrums" of the past and rates shoot higher, which could also now destabilize the financial system because everyone is positioned the other way. Which brings me to... 

(b) The financial system is trapped between two bad outcomes. Either zero/negative rates, which, as Jeff Gundlach warned on Halftime yesterday, would destroy the banking system, savers, and older Americans whose medical inflation is way outpacing their income gains; or, rates rip higher. In that case, a repeat of the 1994 bond market blowup that ultimately bankrupted Orange County, Calif., comes to mind. Keep in mind, inflation from supply shortages is possible this year, and wages were still growing 3% as of this morning's jobs report. That could easily become a catalyst for a bond market selloff. But speaking of local bankruptcies... 

(c) Plunging rates will decimate local communities and mean higher taxes. Cities are already struggling to balance their books, despite the decade-long expansion. One of their biggest obligations is paying the pensions of past and present workers. Let's say a town has $50 million owed in 2030. Well, it needs a lot more money today to hit that future target because there's no return left in "safe" fixed income products. What is the town supposed to do, invest in stocks? That's not actuarily sound, obviously. So they need to put more money aside today for pensions out of a fixed budget. That means less going to the rest of the services they need to provide: schools, roads, policing, trash pickup, etc. They can either cut back those services or raise the cost of them. Or, they can raise taxes generally to bring in more income. Not good for you and me either way. And it's not just towns and cities... 

(d) Pension costs are going to whack Corporate America. The same principle, applied to companies that still have big pensions, means more of their earnings have to go to pensions and less is available to reinvest in the business, pay current salaries, etc. AT&T, GM, Ford, and General Electric were highlighted by Barron's last year for owing in pensions almost as much as their combined market cap. Airlines including Delta and American already had less than 70% of their pensions funded. I cannot imagine what will happen now that rates have absolutely cratered. Although it will certainly favor newer tech companies with 401(k) plans instead of pensions, as if they needed it. 

(e) And the housing market also didn't need it! Here's BlackRock's Rick Rieder: "...that sector is already in great shape and it isn't clear whether the extension of mortgages will happen at lower rates anyway, given the uncertainty today and robust demand for refinancing existing mortgages." Now you have the risk of, yes, sparking another housing bubble. Because lower rates mean higher prices, and people love to chase higher prices, and they'll all want to jump into real estate because you can't get a return anywhere else. We just told my younger sister to tell us where to buy in her local market, Denver. Who knows if we'd actually pull the trigger, but does the Fed really want to encourage us to compete against local homebuyers?  

So, that's why I watch the 10-year yield plunge with a pit in my stomach. No no no no!!! Please make it stop, is all I keep thinking.

Now you have people pricing in a 75-basis-point rate cut this month, which would take us all the way down to 0.25%. As Brian Reynolds writes: "The Fed made the same bad decision as they did in July: answering the money market's call for cuts, but doing so in a half-hearted and ham-handed way that made investors in that market clamor for even more cuts." 

Cuts that I, as I've explained before, do not believe will even solve anything. 

More at 1 p.m.... 


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