Negative Yields Are Spreading. Will This Aberration Become The Norm?

Fears of a marked economic slowdown or even a recession coupled with the willingness of central banks to intervene to cut interest rates are driving investors towards bonds. Prices for these assets have peaked to such an extent that some observers are talking about a bubble in government bonds. When prices rise, yields fall. To this end, yields have shrunk gradually, turning negative for many issuers. There are now 13 trillion dollars of negative-yielding debt in the world, a spectacular increase of 50% year-to-date. In practical terms, this means that investors agree to buy a bond conscious that they will lose money if they hold it until maturity. So investors buy a bond in the hope that rates will fall further and they will be able to sell it during its life at a gain.

It is a change in mind-set.  Previously, investors would buy a bond for its coupon. Now it is bought for its potential capital appreciation, with the investor betting on a rate cut, irrespective of the coupon and yield-to-maturity. The negative rates implemented by the ECB have contributed to this situation, as have the regulation and development of the ETF (trackers) market. Indeed, by buying a tracker, investors aim for capital appreciation, without knowing the yields of the underlying bonds.

As a result, one third of global government debt has negative yields, and this figure is as much as 60% for the eurozone. Most eurozone countries are therefore financing themselves at negative rates on maturities of up to ten years. So investors seeking compensation are moving into corporate debt, but even there, negative yields exist. The highest-rated issuer category, known as 'Investment Grade', contains nearly 40% of negative-yielding bonds.

More surprisingly, the phenomenon is spreading to the ‘High Yield’ category. It is riskier because it concerns companies whose balance sheets are fragile, but it has recently included a dozen bonds (examples of issuers: Altice, Nokia, Telecom Italia, Fiat Chrysler Finance Europe) which trade in the market with negative yields. But ironically, investors are far from gaining high yields on the above-mentioned bonds that belong to the ‘High Yield’ category. High Yield bonds offer an average yield of 3.0%, so this singularity is still marginal today. It only concerns 2% of bonds in this asset class. Most have the characteristic of being callable in the very short term, which justifies that they offer lower yields than other bonds with longer maturities. However, this phenomenon could spread further due to the large number of bonds in the index that may be redeemed early (two thirds) and the large number of bonds that already offer very low yields (one quarter have yields below 1%). For example, it would need a rise in inflows, or for the ECB to go back to buying corporate debt. This would be certainly limited to Investment Grade debt, but would indirectly help to lower yields on High Yield debt as it would incite investors seeking decent compensation to move into this riskier debt category.