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Sleepwalking in a world turned upside-down ..... ref :- "Negative rates take markets into surreal territory" , by Gillian Tett, Opinion in the Financial Times

June 28, 2019

 

Sleepwalking in a world turned upside-down .....

 

ref :-  "Negative rates take markets into surreal territory" , by Gillian Tett, Opinion in the Financial Times

 

Ms Tett is usually worth a read , and this morning is no exception. It's not as though negative rates and bond yields , that seemingly insane condition that makes lenders pay borrowers for the privilege of lending them money, is a breaking story  --  they've been around for a few years now (well, about 20 if you include the obscure corners of Japanese money markets). But in the wider scheme of things it was not so long ago that economists  --  anybody, in fact  --  would still have looked at the phenomenon of negative returns and thought :" This is crazy ! ". But we've since witnessed negative numbers marching further and further down the yield curve, and being applied to a greater and greater percentage of global debt, and the reaction seems to be : "So what ?" ..... and that really, is Ms Tett's point.

 

Just to remind ourselves of how far we've gone down this road, the total pile of global, negative-yielding debt sits at about $13 trillion, surpassing the figure set three years ago before a period of growth pushed rates a little higher for a while. As we've said before (probably because it seems so unreal) , Germany's 10yr government debt has traded at a record low yield of MINUS -0.33%. France's equivalent, despite that nation's high level of indebtedness, has dipped below zero, as has Sweden's. In matters that might resonate even more clearly to the man or woman in the street, Ms Tett tells us that in Germany yields on 5yr bonds issued by mortgage banks have been trading at MINUS -0.2% (as opposed to +5% 10 years ago). That means that investors are paying to lend money into the property sector ... THE PROPERTY SECTOR, FOR GOODNESS SAKE ! In Denmark, banks will even pay you to take a mortgage from them ....

 

It's true that in the world's largest economy, the United States, rates and yields are still positive. The yield on 10yr Treasuries is currently hovering around 2.00 % .... but many bond gurus had expected yields to be a lot higher than that at this stage (3% ? 4% ? 5% ?), and in real terms (i.e. taking inflation into account) a return of 2% is almost negligible. If you remember that the last quarterly US GDP figure showed growth running at 3.1%, that's pretty extraordinary. At least, judging by previous standards you would call it so but these days neither investors nor the powers-that-be seem to think it worthy of much comment ..... and that's the danger.

 

Tumbling bond yields, never mind moves into negative territory, always need to be taken seriously as they are a good indicator of a faltering economy. If the moves get so extreme that the yield curve becomes inverted (shorter-term rates higher than longer-term), as it already is in certain parts of the curve, that's often a signal of recession on the way. Whether that particular prophesy comes to pass or not, it's something the markets are well aware of and have witnessed many times over the years.

 

What's different about this occasion is that market psychology looks to have changed. Steep falls in rates and yields have historically been a function of specific events and/or their remedies. ... for example the Asian financial crisis of 1997, or the 2008 Financial Crisis and the radical measures taken by central banks to easy monetary policy as a result. For sure there are some major concerns for the market right now, not least the possibility of a total bust-up on trade between the US and China (and elsewhere) that would obviously have a detrimental effect of global growth. But there isn't any one particular event or circumstance that one could point to as the culprit behind crashing yields.

 

That suggests that we have moved into an era of structurally lower rates. Accepted wisdom has always had it that strong growth begets inflationary pressure which in turn begets higher rates. But this time, most noticeably in the US, a long period of decent growth and tight labour markets has failed to produce any real inflationary pressure. The jury remains OUT on the exact causes of that .... some combination of low productivity, demographics (ageing populations etc) and advances in technology , most likely. But whatever the case, the suggestion is that if during a period of strong growth and even hikes in short-term rates by the Fed, yields have not only been unable to climb from their crisis-era lows but are actually resuming their downward spiral, then we'd better get used to a whole new (and lower) long-term playing field when it comes to yields.

 

Of course, it wouldn't be entirely accurate to say that the current moves have no connection to specific events or actions. The Quantitative Easing programmes initiated by central banks after the Financial Crisis are still largely in place, with only the Fed having let a small amount of the bonds they purchased run off their balance sheet. The Bank of Japan is still active, and now there's talk that the European Central Bank may soon resume their purchases. That has the effect of forcing investors, looking for increasingly rare safe-havens, to chase down yields (yields down / prices up, remember), even into negative territory. In that light, the idea that ultra-low rates are here to stay seems reasonable and it's no surprise that so many now adhere to that view.

 

The danger however is that the more faith one has in the presumption that there has been a long-term structural change in the future for rates and yields, the less likely one is to protect oneself from any sharp adverse moves .... in this case , a spike higher. Investors of all types, confident that there can be no serious upward moves under the new structure, have left themselves extremely vulnerable to just such an event. No one is saying that it's likely anytime soon, but then again if you'd said ten years ago that German mortgage bonds would be trading with negative yields, they'd have been calling for the men in white coats .....

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