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Central banks around the world have fallen all over each other lowering
their benchmark interest rates. On Tuesday, the Reserve Bank of Australia was
the latest, cutting its cash rate to an all-time low of 2.25%. It didn’t
mince words: “A lower exchange rate is likely to be needed to achieve
balanced growth in the economy.” A rare admission of escalating the currency
war. The Aussie dollar immediately swooned.
Two weeks ago, the Bank of Canada suddenly cut its overnight interest rate
by 25 basis points. Other central banks have chimed in. Japan’s rate has been
at zero for years. “Negative deposit rates” have infected a number of central
banks, including the ECB.
In this environment, the Fed is talking about raising rates from
zero to next to zero, but the markets are not following its hints and are
trying to force it to back off.
Ten-year government bond yields in Japan and Germany dropped closer to
zero, before bouncing off in a sharp rally to 0.39% and 0.31% respectively.
This is called the “Japanification of Germany.”
Back in August 2013, when 10-year JGBs still yielded around 0.8%, I wrote,
Why
I’m Deeply Worried About Japan – And Why Betting On The Collapse Of JGBs Is A
Horrible Idea, which has become a leitmotif. Japan’s fiscal situation has
deteriorated since, but JGBs have risen and yields have dropped, with shorter
maturities sporting “negative” yields. JGB shorts have been kneecapped.
Inflation is 2.4% as measured by the all-items index, and 3.1% for goods.
Financial repression has become the rule.
The ECB is barreling down a parallel path, but at least in the Eurozone
workers and consumers currently enjoy true price
stability, though that is total anathema to central banks, most
governments, the media, and corporations who have become dependent on using
inflation for their own benefit. Since October 20, the ECB has bought €40.3
billion in “covered bonds,” which are backed by assets and guaranteed by the
issuer. By September, in anticipation, covered-bond yields became negative.
It also bought €2.3 billion in asset-backed securities to push their
yields down. Throughout, those who own these types of securities are watching
their values balloon into the stratosphere.
So the ECB decided in January to buy €60 billion in government bonds a
month. This decision had been expected for a long time. And government
bond yields have turned negative in an increasing number of member states,
for longer and longer maturities.
European high-grade corporate bonds have followed in lockstep. Nestle SA,
the Swiss food conglomerate, might be the first company whose debt
trades with a negative yield. Its notes, rated Aa2 and not even triple-A, due
October 2016 were quoted at a yield of 0.05%, just a hair from zero, Bloomberg
reported. Breaking below zero would be a logical step.
Notes that drug maker Roche Holding issued in 2009 and that mature in
March 2016 traded at a yield of 0.09%. Whoever bought these notes in 2009 and
sold them today made a chunk of money, thanks to the ECB. It’s
“market-driven,” said Roche’s media relations head, Nicolas Dunant. The bond
has become “increasingly attractive for investors in the current low-rate
environment.”
The average yield of high-grade corporate euro bonds dropped to a record
low of 0.987%. Less than 1%! At the end of 2013, the average yield was still
2.1%. They may be headed where covered bonds already are: Deutsche Bank’s
home-loan-backed covered notes maturing in 2018 yielded a negative
0.03%. Mortgage rates in Denmark are already negative so that people
are paid to take out mortgages; it’s fighting back in the currency war
that the Eurozone has embarked on.
Investors are going to pay the price. But where else are they going to
park their money? They’re going to pay for parking it at the bank,
based on the negative deposit rates the ECB has inflicted on its banks that
in turn have started to pass them on to their large depositors. The only hope
for investors is that bonds will rise even further, with yields
dropping ever deeper into the negative. This way, they might make money off
the price, if they sell at the right time.
But how much longer can this absurdity go on?
“The basic logic is for yields to fall, but we must brace for widening
volatility,” cautioned Kazuhiko Sano, the chief bond strategist at Tokai
Tokyo Securities, at a January 27 event in Tokyo, according to Bloomberg.
He’d predicted that 10-year JGB yields would drop to 0.5% by 2013 and to
0.25% by March this year. Ahead of his schedule, it plunged to 0.195% on
January 20.
So now he sees the yield drop to 0.1% by March 2016, a good day away from
going negative. The median forecast of nine economists that Bloomberg
surveyed expected the yield to rise to 0.5%.
The Bank of Japan, by printing ¥12 trillion ($102 billion) a month to buy
mostly JGBs, is monetizing over 90% of the new debt the government is
issuing. It has become the relentless bid, and the JGB market has withered.
The buying binge will drive down yields further, Sano said, but price swings
could be wild: “Liquidity has shrunk so much that any selling could cause
yields to spike.”
As I’m writing this, the 10-year yield has jumped to 0.39% – doubling
in less than two weeks! Sano wasn’t kidding about wild volatility.
The potential for a slowdown in the EU could trigger a global recession
and persuade the Fed to delay its first interest rate hike into the nebulous
future. This would further pressure government bond yields, Sano said; “It’s
hard to think Japan will be an exception.”
And 10-year Treasury yields could skid to 1%, despite the Fed’s
rate-hike cacophony, DoubleLine Capital’s Jeffrey Gundlach has been saying
since December. He’d nailed the plunge in Treasury yields last year, while
most gurus thought they’d rise.
These ludicrously low yields, a phenomenon the world has never seen
before, cannot be ascribed to the fear of a global recession. Global
recessions are nothing new. But these yields are.
What these yields do show is that the markets for government debt, and
increasingly for high-grade corporate debt, are completely controlled by
central banks. There is no more price discovery. Risk has disappeared as a
factor. The potential of inflation no longer matters. Any doubts are
immediately pooh-poohed.
By throwing free money around that has to go somewhere,and by making
leverage essentially free, central banks have catapulted asset prices into
absurdity. They have created a mechanism by which governments and
corporations can load up on debt without paying the otherwise normal costs of
capital, and sometimes at an outright profit, while at the same time
depriving those whose money this is – regular investors, pension funds,
savers, and others – of a return. Confiscation comes to mind.
But there are costs. It saddles these governments and corporations with a
future problem: debt doesn’t just go away. It has to be rolled over (or be
paid off, a novel concept in these circles). But many of these entities
cannot afford higher rates on their pile of debt. Then what? Force rates to
or below zero forever?
It’s going to be tough. This is an economy where risks can no longer be
priced, where the cost of capital is nil for some, and where price discovery
isn’t handled by market participants but by central banks. Throw enough money
at anything, and you’ll kill it.
So hedge-fund guru Paul Singer explains why they’re all buying these
assets: a “wish not to be run over.” Read… Immensely
Concentrated Positions in “Fantastically” Overpriced Markets with “Unlimited
Tolerance for Risk”
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