If things continue as they are, positive interest rates will soon become extinct.
In the last four months, the global volume of government bonds with negative yields has almost trebled. The figures are breath-taking. At the end of December, the volume of bonds in negative territory amounted to “just” $2.4 trillion (€2.1 trillion). Since then it has ballooned to $6.6 trillion.
Welcome to the world of negative interest rates, where the laws of capitalism have been turned on their head. A year ago, negative rates were a phenomenon confined to northern Europe, Japan and Switzerland. But thanks to a mix of ultra-accommodative central bank policies, global fears of slowing growth and mounting risk-aversion among investors, the trend is spreading across the Western world.
The yields on 27 percent of the bonds listed in JP Morgan’s Government Bond Index are now negative. That means that people who lend these governments money and hold on to the bonds until they mature will make a loss.
“One almost has the impression that the market wants to go below the magical zero percent level.”
The money-printing, or quantitative easing, policies being operated by central banks is a major cause. The Japanese central bank, for example, has kept its interest rates at 0.3 percent since the end of 2008. It’s been buying bonds for the past 15 years and is currently purchasing bonds worth 80 trillion yen (€630 billion, or $716 billion) each month. The European Central Bank reduced its key rate to zero four weeks ago and increased its bond-buying program by €20 billion to €80 billion per month.
But central banks aren’t the only culprits. “The flight to quality is extreme at the moment,” said Martin Lück, chief investment strategist for Germany, Austria and Eastern Europe at fund management company Blackrock. In times of uncertainty, investors tend to opt for sovereign bonds issued by the big industrial nations because they can at least expect to get their capital back. “The fear of risk is very big in Europe in particular,” said Mr. Lück.
The refugee crisis, Britain’s possible exit from the E.U. in a June 23 referendum, new fears over Greece’s finances, waning budgetary discipline in Spain — against the backdrop of all those problems, the search for safe investments was understandable, he added.
“Add to that fears about China’s economy, low raw materials prices and worries about a possible recession in the United States,” said Gunther Westen, head of asset allocation at French-German asset manager Oddo Meriten.
The uncertainty is reflected in Europe’s stock markets. The broad-based European stock index Stoxx 600 has fallen some 10 percent since the start of the year. By contrast, European bond prices have risen 3.7 percent on average. But as prices rise, the yields keep falling.
The yield on 10-year German government bonds, known as Bunds, fell as low as 0.08 percent this week, close to the all-time low of 0.05 percent reached almost a year ago.
“This time, with economic fears and the increased bond purchases by the ECB, there are more plausible reasons for the yield decline than a year ago,” said Rainer Guntermann, bond strategist at Commerzbank. He wouldn’t rule out that the yield on Bunds could at least briefly slip into minus territory.
Mr. Lück of Blackrock agrees: “One almost has the impression that the market wants to go below the magical zero percent level,” he said.
Investors are focusing on Bunds because they are considered the benchmark for long-term capital market rates in the euro zone. Also, the most important European bond futures contract — the Bund future — is based on the German 10-year bond.
“So a fall in the 10-year Bund yield below zero percent would be a striking step — even though German bonds with nine-year maturities already have negative yields,” said Mr. Guntermann.
Mr. Westen, of Oddo Meriten, agreed that a fall below zero percent couldn’t be ruled out but added: “Anyone who still buys German government bonds at that level in the current environment must be very desperate.” He said fears for the global economy were grossly exaggerated and that bonds issued by southern euro-zone member states and corporate bonds were more attractive investments than Bunds at present.
Ten-year government bonds issued by Spain and Italy respectively yield 1.2 and 1.4 percentage points above Bund yields, and top-rated corporate bonds on average yield 1.1 points more.
One thing is certain though: negative interest rates will remain for a long time to come. “If the Japanese market is taken as a model, yields could fall even further,” said Dave Chappell, fund manager at Columbia Threadneedle Investments. The yield on 10-year Japanese government bonds fell into the red in February. And Japanese companies offer only 0.4 percentage points more on their bonds than the government.
Jens Schmidt-Bürgel, appointed by rating agency Moody’s as country manager for Germany last October, defended the European Central Bank but said its policy was hitting financial institutions hard.
“It’s positive that the refinancing costs of governments and companies have declined as result of the ECB’s policy,” he told Handelsblatt. “But banks and insurers are suffering heavily from the low-interest rate environment. They depend on capital market rates, and the longer the low-interest rate phase goes on, the more these sectors will come under pressure.”
He said it would not have been better if the ECB had done nothing, or taken less drastic action to cheapen money in the euro zone.
“In that case we might have gotten problems on the other side,” he said. “The economies in the euro zone may then have faced even bigger challenges. Investors were very nervous again in January and February in particular. And the tender shoots of economic recovery we have in the euro zone are definitely at least partly attributable to lower interest rates.”
Andrea Cünnen works on Handelsblatt’s finance desk in Frankfurt, reporting on the bond markets. To contact the author: firstname.lastname@example.org