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, even before it started buying, 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 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, central banks have catapulted asset prices into
absurdity. They have created a mechanism by which governments and
corporations can load up on debt without real costs involved, 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. 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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