The value of negative-yielding bonds swelled to $13.4tn this week, as negative interest rates and central bank bond buying ripple through the debt market.
The universe of sub-zero yielding debt — primarily government bonds in Europe and Japan but also a mounting number of highly-rated corporate bonds — has grown from $13.1tn last week, according to figures compiled by Tradeweb for the Financial Times.
That has further squashed bond yields, and forced investors to scurry into emerging markets, junk bonds and ultra-long dated government debt to snap up what little remains of potential returns. Money is also spilling into the global stock market, helping the FTSE All-World index to a 5.3 per cent gain this year and pushing all three main US equity indices to a “trifecta” of fresh records this week.The New Zealand central bank became the latest to cut interest rates again, while the Bank of England recently restarted its quantitative easing programme to combat the economic slowdown that is expected to follow the UK’s vote to leave the EU. About a quarter of the global economy now has negative interest rates.“It’s surreal,” said Gregory Peters, senior investment officer at Prudential Fixed Income. “It’s clear that central banks are dominating markets. There’s a race to the bottom. Central banks are the main drivers of this, it’s not fundamental.”
Some investors and analysts are starting to fret that the swelling universe of negative-yielding bonds is distorting global markets and causing more economic damage than gains.
“There’s too much acceptance of this,” Mr Peters said. “We’re talking about it in a cavalier way, but that’s not appropriate. It’s extremely distortive, and if we see a pick-up on the fiscal side, or inflation, it will look less comfortable sitting in this negative yielding universe.”
Exceptionally subdued borrowing costs and the underwhelming health of the global economy has sparked mounting speculation that countries will begin to ease fiscal policy, spending more money on infrastructure and cutting taxes to reinvigorate growth.
Japan has already unveiled another dose of government spending, which underwhelmed investors, but some economists expect the US to loosen the reins after the presidential election in November, and a further easing back of austerity in the eurozone.
There’s too much acceptance of [negative-yielding bonds]. We’re talking about it in a cavalier way, but that’s not appropriate. It’s extremely distortive
- Gregory Peters, Prudential Fixed Income
Michael Hartnett, Bank of America Merrill Lynch’s chief investment strategist, predicted that there would be a “fiscal flip” in the coming year. “The bigger picture narrative is the policy baton is passing from monetary to fiscal stimulus in 2016-17,” he wrote in a note to clients this week. “We are convinced that the flip from monetary to fiscal policy will drive asset allocation and asset prices in coming quarters.”
Mr Peters also expected an inflection point on government spending in the coming year, driven by the need to reinvigorate economies and encouraged by exceptionally subdued government borrowing costs, which could reverse the slow ballooning of the sub-zero bond yield universe.
“If you’re not going to unleash the fiscal hounds with negative rates, why bother? There needs to be more of a relenting of the fiscal reins,” he said. “If 2017 is more of a fiscal year then it makes negative yields more challenging.”
But that could prove painful for investors that have dabbled with negative-yielding bonds, expecting that central bank bond-buying will continue to provide a backstop. Fitch Ratings estimated earlier this month that a rapid reversal of yields back to 2011 levels would cause theoretical market losses of up to $3.8tn.