Rise of sub-zero bond yields turns economic logic on its head
Even Greece now issues negative yielding debt as number of countries paid to borrow grows
Investors lent €487.5m to Greece’s government last month. When the debt matures after 13 weeks, they will get back slightly less than they paid.
The high price raised eyebrows in bond markets. Investors had refused to lend to Greece at any price during the eurozone’s 2009-2015 debt crisis, leading to three sovereign bailouts. Now, they are paying Athens to look after their cash.
The dramatic turnround is partly a sign of the gradual healing of Greece’s economy and government finances after a brutal slump. But the biggest drivers have been external and the Greek bond sale is only the tip of an enormous global debt iceberg.
After an almighty bond rally this year, about $11.5tn of debt — more than a fifth of total debt issued by governments and companies around the world — trades at negative yield. This means investors who hold it to maturity are guaranteed to lose money.
The rise of sub-zero yields turns standard economic logic on its head. Starting in conventional havens such as Japanese and German government debt, the increase has confounded investors by spreading to bonds usually seen as high-risk investments.
“Greece selling at negative yields is absurd,” says Mohamed El-Erian, chief economic adviser at Allianz and former boss of bond investing giant Pimco. “It shows you the extent to which markets are distorted. One by one, things that seemed impossible a few years ago have happened.”
Bond prices have soared as central banks have responded to a slowing global economy with increasingly aggressive easing measures. These have included negative interest rates and huge asset purchases in Japan and the eurozone.
The global rally has stalled since the pile of debt with sub-zero yields peaked at $17tn in late August. But the Barclays Global Aggregate Index, a broad gauge of global bond markets, is nevertheless up 6 per cent this year.
With global yields at record lows, many investors question whether markets can rally much further. If they cannot, investors buying today are guaranteed to make a loss.
Some will continue to invest, regardless. Insurers and pension funds are required to hold long-dated government debt to match long-term liabilities they have to policyholders or pensioners. Many banks must hold bonds as high-quality collateral for lending. “There’s still quite a big class of investors who have no option but to invest in negative-yielding assets,” says Isobel Lee, global bonds head at Insight Investment. “They might be very unhappy about it but nothing else really works for them.”
Some are simply protecting their capital, swallowing a small negative return rather than taking greater risks elsewhere, or facing an even more negative rate at the central bank. For others, one question is becoming increasingly urgent: why buy an asset that is guaranteed to lose you money?
“I don’t think it makes any sense whatsoever for a long-term investor to buy government bonds with negative yields,” says Oliver Brennan, senior macro strategist at research provider TS Lombard. “This fundamentally changes the way these bonds behave, and it’s likely we’ll only see the results when there’s a crisis.”
Some fund managers are questioning the role typically played in investment portfolios by highly rated debt as a kind of counterweight to riskier assets. The logic of a traditional “60/40 portfolio”, where 60 per cent of money is deployed in stock markets and the rest in investment grade bonds, is that any sell-off in the former should be cushioned by gains in the latter.
If bond prices do not have much room to rise, however, that no longer makes sense, says Ludovic Colin, a portfolio manager at Vontobel Asset Management. To compensate for a 10 per cent drop in equity markets, European investors would need a bond rally that pushed Germany’s 10-year yield from minus 0.35 per cent today to almost minus 2 per cent.
Mr Colin thinks that is highly unlikely. At some point, investors will prefer to keep their money in cash rather than even more deeply negative bond yields, he argues.
“People call these bonds a safe haven but they’re not safe,” he says. “You generate a negative return if nothing happens and they don’t offer much protection in an equity sell-off. We need an episode where equities fall and bonds fall, too, for people to wake up.”
Despite such reservations, there is little prospect of negative yields soon disappearing altogether from the investment landscape. Japan’s central bank continues to control bond yields with its asset purchase programme as part of an effort to generate elusive growth and inflation. The European Central Bank, which has just restarted its own bond-buying programme after a 10-month hiatus, is expected to hold interest rates below zero for years into the future.
Even so, there may be limits to how much bond investors will stomach. Germany’s 30-year bond sale in late August — which for the first time for such a long-dated bond offered investors no regular interest payments — attracted the weakest demand at any German auction since 2011. A series of weak bond auctions in Japan recently has fed the global sell-off.
Mr El-Erian detects the stirrings of investor indigestion over the glut of negative-yielding debt. If there is a pushback, he says, it will come from the primary market, where investors buy new debt from countries and companies.
“That’s where the really big investors get their allocations.” Mr El-Erian says. “If you get a buyers’ strike it will be a sign that people have lost faith in the effectiveness of central banks. Things will get messy very quickly.”
In short, there will be big repercussions for all assets, although quite how remains unpredictable.