Low Yield, No Yield, Negative Yield – Buy Now But Don’t Forget To Sell

To many onlookers, since the great financial crisis, the world of fixed income securities has become an alien landscape. Yields on government bonds have fallen steadily across all developed markets. As the chart below reveals, there is now a record US$13trln+ of negative-yielding fixed income paper, most of it issued by the governments’ of Switzerland, Japan, and the Eurozone: –

Bloomberg - Negative Yield - 21st June 2019

Source: Bloomberg  

The percentage of Eurozone government bonds with negative yields is now well above 50% (Eur4.3trln) and more than 35% trades with yields which are more negative than the ECB deposit rate (-0,40%). If one adds in investment-grade corporates the total amount of negative-yielding bonds rises to Eur5.3trln. Earlier this month, German 10yr Bund yields dipped below the deposit rate for the first time, amid expectations that the ECB will cut rates by another 10 basis points, perhaps as early as September.

The idea that one should make a long-term investment in an asset which will, cumulatively, return less at the end of the investment period, seems nonsensical, except in a deflationary environment. With most central banks committed to an inflation target of around 2%, the Chinese proverb, ‘we live in interesting times,’ springs to mind, yet, negative-yielding government bonds are now ‘normal times’ whilst, to the normal fixed-income investor, they are anything but interesting. As Keynes famously observed, ‘Markets can remain irrational longer than I can remain solvent.’ Do not fight this trend, yields will probably turn more negative, especially if the ECB cuts rates and a global recession arrives regardless.

Today, government and investment grade corporate debt has been joined by a baker’s dozen of short-dated high yield Euro names. This article from IFR – ‘High-yield’ bonds turn negative– explains: –

About 2% of the euro high-yield universe is now negative yielding, according to Bank of America Merrill Lynch.

That percentage would rise to 10% if average yields fall by a further 35bp, said Barnaby Martin, European credit strategist at the bank.

He said the first signs of negative yielding high-yield bonds emerged about two weeks ago in the wake of Mario Draghi’s speech in Sintra where the ECB president hinted at a further dose of bond buying via the central bank’s corporate sector purchase programme. There are now more than 10 high-yield bonds in negative territory…

The move to negative yields for European high-yield credits is unprecedented; it didn’t even happen in 2016 when the ECB began its bond buying programme.

During Q4, 2018, credit spreads widened (and stock markets declined) amid expectations of further Federal Reserve tightening and an end to ECB QE. Now, stoked by fears of a global recession, rate expectation have reversed. The Fed are likely to ease, perhaps as early as this month. The ECB, under their new broom, Christine Lagarde, is expected to embrace further QE. The corporate sector purchase program (CSPP) which commenced in June 2016, already holds Eur177.8bln of corporate bonds, but increased corporate purchases seem likely; it is estimated that the ECB holds between 25% and 30% of the outstanding Eurozone government bond in issue, near to its self-imposed ceiling of 33%. Whilst the amount in issues is less, the central bank has more flexibility with Supranational and Euro denominated non-EZ Sovereigns (50%) and greater still with corporates (70%). In this benign interest rate environment, continued compression of credit spreads is to be expected.

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