A deep pool of debt with below-zero returns is increasingly betting on European bonds. In a matter of weeks, German 10-year bond yields fell to the most in July from flirting with zero for the first time in two years, going back to minus 0.46% since the start of 2020. That fall – which has propelled bond prices – has helped push negative-yield debt volumes in Europe to a near six-month high of 7.5 trillion euros ($8.9 trillion).
Traders were alerted by the inflation bet, which initially raised borrowing costs, but lost heights after major central banks insisted on continued support. At the same time, the spread of Covid-19 variants stoked demand for the safest government loans, reviving a business that dominated global markets last year amid the pandemic.
Strategists at HSBC Holdings plc and ABN AMRO Bank NV never shied away from their call for benchmark bond yields at minus 0.50% by the end of 2021, which has been in effect since the first half of last year. That will erase a large portion of this year’s 54-basis point trough-to-peak advance.
The European Central Bank said last month that current inflation is driven by temporary factors, and any change in stance would depend on hitting the new 2% inflation target.
HSBC’s forecast was “based on the assumption that there will be no rate hikes before the end of 2023,” said strategist Chris Atfield. “It is mostly market priced now, helped by the new ECB forward guidance.”
Money markets have quickly cut back on policy tightening after the ECB revised guidance on interest rates, saying it would not react immediately if price hikes exceed that target for a “transient” period.
According to swap contracts, in July, traders wiped out 20 basis points more from rate-increasing bets. This is the biggest decrease in nearly two years, and they suggest they expect the ECB deposit rate to be below zero in five years.
HSBC’s Attfield said that “the new forward guidance criteria for rate hikes since 2008 will not have been met at any point,” highlighting the challenging task facing the ECB as it seeks to open up record monetary stimulus.
The euro area pulled out of recession in the second quarter, and headline inflation climbed to 2.2% last month. According to Mayva Cousin of Businesshala Economics, while rising pressures could push the annual CPI rate to more than 3% in the coming months, the increase will prove to be temporary and inflation is expected to decline sharply in early 2022.
According to a Businesshala survey, strategists see the German 10-year yield as low as minus 0.14% by the end of the year, down from minus 0.035% nearly a month ago. ABN AMRO strategist Flortje Merten sees a drop to minus 0.5%, given the balance between rate expectations and the state of the euro-regional economy.
“Further rate hikes and more optimistic sentiment would be two opposing factors and could keep Bund yields around these low levels,” Merton said.
- The Bank of England will meet with investors on Thursday to discuss the possibility of a split vote on bond purchases, given recent sharp remarks by some members of the Monetary Policy Committee.
- European sovereign supplies should remain moderate at around 17.5 billion euros, according to Commerzbank, with auctions in Germany, Austria, France and Spain.
Historically, people give the government their money, instead of spending it, with the promise of being paid back, with interest. Now, governments are essentially getting paid to borrow money, as people become increasingly desperate for a safe haven for their wealth. The cycle becomes self fulfilling as negative rates raise further concerns about the economy.
“Bonds are supposed to pay the owner of capital something to pry the money out of their hands. But no … ” said co-founder of DataTrek, Nicholas Colas. Central banks often lower interest rates to grow the money supply in the economy, fuel demand and provide growth momentum. Other key drivers for monetary policy easing are weakening domestic outlooks, falling annual growth rates, low inflation and weakening business and consumer confidence. And in Europe’s case, make up for the lack of a coordinated fiscal response.
Another reason for negative yielding debt worldwide could be that institutional investors, like pension funds, are forced to keep buying bonds because of liquidity requirements. PIMCO’s global economic advisor Joachin Fels said there are also secular factors like demographics and technology that drive rates lower.
“Rising life expectancy increases desired saving while new technologies are capital-saving and are becoming cheaper – and thus reduce ex ante demand for investment. The resulting savings glut tends to push the “natural” rate of interest lower and lower,” said Fels.