German Bunds poised to join $10 trln negative yield club
LONDON, June 10 (Reuters) – The $10 trillion club of sovereign bonds with yields below zero looks poised to get a new member: 10-year German Bunds.
Bund yields, the benchmark for borrowing costs in the euro area and an obligatory feature of many fixed income portfolios, are at record lows of just 0.02 percent.
Many in markets are bracing for a near-term dip below zero, as a confluence of political risks, ultra-loose monetary policy, concerns about global growth, and no sign of inflation despite rising oil prices lifts demand for Bunds.
And, unlike a year ago when Bund yields hit a record low only to catapult higher on a surprise uptick in inflation, investors seem happy to keep buying.
"If you look at the pattern in Bund yields, you’d think we should be nervous but we’ve got far lower in economic expectations and the consensus on monetary policy," said Peter Chatwell, head of euro rates strategy at Mizuho.
The idea of investors paying governments to hold their debt – unthinkable a few years ago – has become commonplace in developed country bond markets. Japan’s 10-year yields hit a record low of minus 0.155 percent on Friday and even its 15-year bonds yield less than zero.
That this has happened in a week when oil prices topped $50 a barrel for the first time in eight months, potentially boosting inflation, might seem perverse.
The five-year, five-year breakeven forward, the European Central Bank’s favoured gauge of long-term inflation expectations, tracked oil prices as they fell from above $100 a barrel in June 2014 to lows below $30 in January.
But the measure fell below 1.40 percent on Friday – its lowest level since March and well below the ECB’s near 2 percent target.
"If you look at it in terms of growth expectations and in particular inflation expectations, they are probably more modest than they were a year ago," said Orlando Green, European fixed income strategist at Credit Agricole.
ZERO HERE WE COME
German bonds with a maturity out to nine years have a yield below zero and the average yield of German bonds in circulation turned negative for the first time this week.
Globally, Fitch Ratings estimates sovereign bonds worth $10.4 trillion have negative yields, out of an estimated global total of $60 trillion.
Ten-year Bunds make up almost 45 percent of outstanding German government bonds. If the current 10-year benchmark’s yield turns negative, a further $25 billion would be added to the sub-zero club.
That raises the question of where investors will go next.
Some are already buying longer-dated German debt; 30-year yields fell to more than one-year lows on Friday.
Bond investor Bill Gross of Janus Capital warned in a tweet on Thursday that the global pile of negative-yielding bonds is a "supernova that will explode one day".
The interest rate paid by Bunds is just 0.5 percent, so even a slight rise in the bond yield can outweigh an investor’s return and spark a sell-off that quickly snowballs.
Bund yields fell to a low of 0.05 percent in April 2015 before an uptick in inflation took them above 1 percent by mid-June in one of the biggest Bund routs in history.
For some analysts the change in perceptions towards growth and inflation means the conditions for lower Bund yields are different.
"Psychologically we are at a different place," said Giles Gale, a strategist at RBS, which forecasts Bund yields will fall to minus 0.1 percent this year.
For others, ECB monetary easing and a scarcity of bonds it can buy under its 1.74 trillion euro asset-purchase scheme mean German yields will face downward pressure for some time.
The ECB bought more German, French and Italian bonds than its rules dictate in May and fell short of its target for smaller countries such as Portugal.
Rabbani Wahhab, senior fixed income portfolio manager, London and Capital, said Bund yields near zero did not make him nervous.
"What happened last time is that the ECB was not as clear about what it was trying achieve as it is now and we know inflation will struggle to get to its target," he said. "That’s a powerful change in circumstances compared with a year ago."