The Big Big Story...

The Big Big Story...

| August 27, 2019

A funny thing has happened in global bond markets.  The world now has almost $17 trillion of debt with negative yields.  In June, the Wall Street Journal identified 17 countries with negative bond yields, depending upon maturity.  The list of issuers included not just Germany and Japan, but Portugal, Italy and Spain – all members of the so-called PIIGS group (see here).  More recently, Germany issued a 30-year bond with a negative yield – the investors put up € 824 million now and if all goes well they will receive back € 795 million in roughly 30 years (see here).  Some investment grade corporate and even some junk bonds in Europe have negative yields (see here).  Now, in Denmark, homeowners can take out negative rate mortgages (see here).

All of this seems through-the-looking-glass.  Until fairly recently, the risk of widespread negative rates outside the context of a global crisis appeared laughable.  Most US investors assumed that rate risk was largely to the upside, with US rates near all time lows and well below historical averages, investors believed that the risk was asymmetric – rates could rise significantly, but they couldn’t go below zero.  Could they?

US 10 year Treasury yields are currently 1.48%.  10 year German government bonds (Bunds) are -0.70%.  Japanese 10 year government bonds (JGBs) are at -0.28%.  French 10 years at -0.42%.  Clearly, US fixed income investors need to factor in the risk of rising rates, given where rates are relative to historical averages (see chart above).  Indeed, rising interest rates are a serious risk.  But given yield levels outside of the US, the prospect of lower or even negative rates in the US must also be considered.

Borrowers, of course, benefit in this low/negative rate environment.  Quite a novel way to reduce government debt.  Savers, lenders and fixed income investors suffer.  For the pension funds, banks and insurance companies that are forced to invest at negative rates, the impact of such returns on bonds will flow through to their businesses and beneficiaries  (see here for today’s Bloomberg story “Pension World Reels From ‘Financial Vandalism of Falling Yields”).

Does this make any sense?  Not from where I sit.  I guess that if you believe Europe will experience price deflation (a negative rate of inflation) for the next thirty years, a German government bond at low negative yields might work out ok.  Otherwise, the investor is just locking in a loss in both nominal and real (ie inflation adjusted) terms.  Ultimately, to me this situation does not feel like a natural equilibrium, rather a manipulated market driven by central banks.  From PIMCO “The BOJ now owns about half and the ECB about 30% of the bonds issued by their respective governments, according to Bloomberg.”  We sit in unchartered territory.