Increasingly, many developed world countries’ fixed-interest securities’ yields have gone sub-zero. German government debt yields are currently negative out to 17 years.i Japanese? 15 years.ii Whilst negative long-term rates in Germany and Japan aren’t particularly new, it seems the condition is spreading. Austrian, Dutch, French, Finnish, Swedish and Swiss sovereign debt yields recently turned negative out to 10 years.iii All told, the amount of negative yielding debt globally hit a record €11.5 trillion in June, garnering headline attention in financial publications we follow.iv What—if anything—should investors take away from this phenomenon?
Pundits we read fret growing piles of negative yielding debt show investors see no opportunities for growth. They argue this augurs recession, saying negative rates signal mounting global risks—from trade disputes to geopolitical flare ups—and that fiscal and monetary authorities are powerless to prevent deteriorating fundamentals and deflation. Other pundits suggest historically low and negative long-term rates mean the developed world is entering a “new normal” of weak growth. They fear aging demographics and high-debt loads doom countries to decades of stagnation—like Japan—with central banks unable to raise rates for fear of mass defaults and financial crisis. Meanwhile, still others worry negative yielding debt is the sign of a bubble—one poised to collapse once investors return to their senses and realise paying governments to borrow money is irrational.
But we don’t think negative rates are signalling fundamental economic weakness. Pundits seem to be overthinking a likely temporary flight to safety, in our view. Beginning in May, we think investors apparently sought havens amidst a rocky spell in equity markets and increasingly dour sentiment, especially in Europe. June’s ZEW Economic Sentiment Index for the eurozone fell to near its lowest levels since 2012, during Europe’s sovereign debt crisis.v Current IFO and Sentix business and investor confidence surveys paint similarly pessimistic pictures.
Negative yields probably aren’t permanent, though. Nor do we think they are likely to indicate looming disaster. This isn’t the first time rates have been negative. In 2016, negative yielding debt also topped €11 trillion following growth and deflation fears after the UK’s Brexit vote.vi Yet they reversed fairly quickly. For example, after Germany’s 10-year Bund yield dipped negative in June 2016, it flipped positive again by October 2016, as eurozone economic growth reaccelerated, dispelling slowdown fears.vii Negative yields then didn’t deter growth or upend markets. We see no reason for them to do so now.
Markets are likely also reacting to the ECB’s hints at a rate cut or more quantitative easing (QE)—central banks’ programme for buying long-term fixed interest securities to reduce longer-term interest rates. ECB President Mario Draghi’s 18 June speech in Sintra, Portugal seemed to ignite speculation further rounds of “stimulus” are imminent, reversing earlier suggestions policy would gradually normalise. Since markets generally look forward, this apparently gave fresh impetus for fixed-interest security yields to fall throughout Europe, bringing a wider array of countries with negative yields.
In our view, markets tend to “price in” or move on widely expected events before they occur. That includes potential future central bank asset purchases. Negative long-term rates are also a function of the ECB’s negative interest rate policy, in our view. The ECB first cut its policy rate below zero in June 2014, initially to -0.1%, and then over subsequent meetings to -0.4% in March 2016, where it stands today.viii This helped drive European sovereign yields negative during 2016’s summer, but as investors began to anticipate QE’s eventual end—and possible rate hikes thereafter—they reversed higher. We don’t know if there will be a replay this year, but we see a similar dynamic currently at work.
Whilst sentiment can affect government debt yields in the short term, in the longer term, we think supply and demand matter more. These factors have kept rates low for years as well, and they have little to do with the economic outlook, in our view. ECB sovereign debt purchases have taken a significant chunk off the market. Tight budget controls—and surpluses in Germany—have also limited supply. This is forcing banks, institutional and individual investors seeking high-quality government debt to look further afield, in our view.
Meanwhile, fixed-interest security demand is robust. To match growing long-term liabilities, insurance companies and pension funds need to buy long-term assets from issuers with high-quality credit, like most developed world governments. Central banks, particularly from many Emerging Market countries, seeking to pad their foreign exchange reserves to guard against currency volatility, have also been large buyers of developed world debt. So have retirement investors, often through investment funds.
As in 2016, we don’t think the mere presence of negative rates are a great reason for investors seeking reduced volatility relative to an all-equity portfolio to avoid owning fixed-interest securities. Whilst long-term government debt might be less attractive, there are alternatives, including investment-grade corporate debt.
So we wouldn’t fret negative yielding government debt. Some fixed-interest security yields may be negative, but we don’t think the economic growth outlook has dimmed. For investors, this also suggests equities remain attractive—and not because central banks are supposedly on the cusp of spurring global growth. When overly dour sentiment obscures a fundamentally fine underlying reality, as uncertainty clears—which we think it will eventually—markets should rally.
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Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
iSource: FactSet, as of 1/7/2019.
iii“Over Half of Euro Zone Government Bond Yields Now Below Zero,” Dhara Ranasinghe, Reuters, 20/6/2019. https://www.reuters.com/article/eurozone-bonds-negative-yields/update-1-over-half-of-euro-zone-government-bond-yields-now-below-zero-idUSL8N23R2FQ
iv“Value of Debt With Negative-Yields Hits $13 Trillion,” Sunny Oh, MarketWatch, 21/6/2019. https://www.marketwatch.com/story/the-persistence-of-subzero-rates-in-europe-may-revive-a-perilous-quest-for-yield-2019-03-23
vSource: Zentrum fur Europaische Wirtschaftsforschung, as of 18/6/2019. Economic Sentiment for the Euro Area, June 2018 – June 2019.
vi“International Banking and Financial Market Developments,” Staff, BIS Quarterly Review, September 2016. https://www.bis.org/publ/qtrpdf/r_qt1609.pdf
viiSource: Federal Reserve Bank of St. Louis, as of 8/7/2019. Long-Term Government Bond Yields: 10-Year: Main (Including Benchmark) for Germany, June 2016 – October 2016.
viiiSource: ECB, as of 2/7/2019. Deposit facility rates, 11/6/2014 – 16/3/2016.