$11 Trillion In Bonds Yield Much less Than Zero. Does It Matter? – Forbes


Participants finish their family photo session of the G20 finance ministers and central bank governors meeting Sunday, June 9, 2019, in Fukuoka, western Japan. Despite efforts by central bankers, rates are sinking again. (AP Photo/Eugene Hoshiko).

According to a recent Bloomberg story, more than $11 trillion in world bonds currently trade at negative rates. This means that holders of these bonds expect to lose money. Remarkably, negative-rate bonds continue to be issued, and buyers continue to buy them. This has caused some alarm among investors, but very low rates may not mean much. Other indicators are more worrisome.

Government bonds in Europe are yielding less than zero. In Germany, the Netherlands and Denmark even 10-year bond yields are in negative territory.

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This is not new: Negative-rate bond debt topped $12 trillion three years ago. To central bankers around the world, the fact that interest rates are once again in negative territory is disconcerting and worrisome.

Disconcerting, because the normal tools of monetary policy – lowering rates and printing money – have shown little or no success in lifting rates or creating inflation. Worrisome, because exceedingly low inflation can turn into deflation – a very hard condition to fight, and one that strongly discourages investment or spending. Why buy anything today when tomorrow it’s expected to be cheaper, or bother to invest when money in the bank will be worth more next week?

It was not supposed to be this way. Pundits complained for years that central bankers were artificially depressing interest rates, punishing savers and creating all sorts of market distortions. The implication was that, without such massive intervention, interest rates would find a higher, more “normal” level.

They turned out to be wrong. The U.S. 10-year note is back below 2%, just as it was before the U.S. Federal Reserve started to “normalize” policy by raising rates and cutting its balance sheet.

Nobody really knows why this is happening. One explanation is that producing things has become much cheaper thanks to automation and globalization. Another explanation is that technological advances that brought us the gig economy have severed the link between wages and prices, which would explain why salaries have barely budged despite soaring employment everywhere. Still others suspect that previously undetected slack in the labor force is keeping wages low.

As rates sink once again, stock-market investors wonder whether this means that the bond market is anticipating an economic crash. But in the last 38 years the link between the absolute level of rates and economic and stock-market performance has been weak. Rates fell throughout that time while the stock market went through booms and busts and the economy expanded and contracted, regardless of whether the 10-year U.S. note was trading at 8%, 5% or 2%. This is the case both for real and nominal rates.

Where interest rates are does not seem to have a discernible impact on the economy or the stock market.

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Where rates are, therefore, does not seem to mean much. Even negative rates appear to have little impact, since we saw them three years ago in Europe and its economy did not collapse. But how various rate horizons relate to one another is a different story.

The difference between 10-yr and 2-yr bond rates, known as the slope of the yield curve, seem to anticipate recessions and stock market weakness. When that difference falls to zero or below, a recession and a stock-market fall typically follows.

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The fact that long-term rates have fallen below short-term rates has attracted a lot of attention in recent months, with good reason: such inversions seems to take place before a recession and a stock market swoon:

Rate inversions seem to anticipate recessions and market crashes. While the US yield curve is not yet inverted between 2 and 10 years, it has gotten close.

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This was the case not just in the United States but also in Europe. In 2007, for example, rates became flat or slightly inverted in several countries, such as Germany or Spain, anticipating the coming recession.

The inversion of the yield curve is not just a U.S. phenomenon. It happened in the past in other countries ahead of recessions.

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Likewise, the difference between the 10-year and the 2-year government bond rates, as well as other interest rate measures, has recently narrowed sharply both in the United States and throughout Europe. While the negative rate environment may not be as meaningful, investors are wise to be concerned about where rate differences between maturities are headed.



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