(Bloomberg Opinion) — The Federal Reserve has a lot to worry about these days. And while it’s not often mentioned, at the top of the list should be preventing rates on longer term U. S. Treasuries, the world’s risk-free benchmark securities, from falling to zero.
Treasuries play a critical role in providing ample liquidity to the global financial system because they are a manifestation of the dollar’s reserve currency status. As such, they are the most important store of value and a critical hedging instrument for global market participants. The Treasury market is also the primary vehicle through which the Fed transmits monetary policy.
But if yields on benchmark 10-year Treasury notes go to zero — a no longer ludicrous suggestion after Russia walked out of the OPEC+ meeting without a deal — then all of those key roles get upended. Especially hard hit will be banks, insurers and pension systems worldwide.
The business model of banks is predicated on borrowing at low short-term rates and lending the proceeds at higher long-term rates. But if the gap between short- and long-term rates evaporates, lending would come to a standstill, especially if this were to happen with nominal yields falling to zero. As for pensions and insurers, they need returns of 6% to 7%, which they are definitely not getting from their holdings of stocks or credit-related securities these days. The need for potential bailouts of pensions would become a very real prospect for federal authorities.