Black Hole Engulfing the World Bond

The Black Hole Engulfing the World’s Bond Markets

By John Ainger 13 July 2019, 00:00 GMT-4



Theres a multitrillion-dollar black hole growing at the heart of the worlds financial markets. Negative-yielding debt — bonds worth less, not more, if held to maturity — is spreading to more corners of the bond universe, destroying potential returns for investors and turning the system as we know it on its head. Now that it looks like sub-zero bonds are here to stay, theres even more hand-wringing about the effects for , pensioners, investors, buyout firms and governments.

1.Why invest in a bond that will lose you money?

Typically, bonds are the safest assets on the market, so many investorsat times of heightened market stress, say aor. A bond can have a modestly positive coupon when issued by a government, institution or company, but once it starts trading, high demand by investors can push its price up — and therefore its yield down — to such an extent that buyers no longer receive any payment. Some funds track government bond indexes, meaning they must buy the bonds regardless of the yield. And some investors can still make positive returns on these bonds whenfor currency swings.

2.How much is being bought?

Negative-yielding debtin June, having, and now makes up around 25% of global debt. In Germany, 85% of the government bond market is under water. That means investors effectivelythe German government 0.2% for the privilege of buying its benchmark bonds; the government keeps 2 euros for every 1,000 euros borrowed over a period of 10 years. The U.S. is one of the few outliers, with none of its $16 trillion debt pile yielding less than zero, but across the world, strategists are warning that the problem may get worse.

3.Why is this reason for worry?

Negative rates are at odds with basic principles of the global finance system. One important law of financial logic – if you lend money for longer, you should see a higher return – has been broken,Marcus Ashworth, a Bloomberg Opinion columnist covering European markets. The time value of money has essentially disappeared. (Has it ever: The so-called century bondstwo years ago, which mature in 2117 and initially offered a 2.1% return,about 1.2%.) All this can push investors intoin the hunt for returns, raising the chances of bubbles in financial markets and.

4.Who benefits from negative rates?

Governments, for one. The incentive to borrow money is never greater than when you are being paid to do so. Germany, for example, is being subsidized to issue debt over the next 20 years, though that does not necessarily mean it will boost. Companies that issue bonds alsoof record-low borrowing costs. So do private-equity firms, which typically use leverage to acquire companies and see greater opportunities when () capital is cheap. Homeowners with variable-rate mortgages also have reason to celebrate.

5.Who gets hurt?

Pension funds and insurers, traditionally big investors in government bonds, are in a particular predicament: Their liabilities grow steadily as clients age, but often they are required not to take on big risks.see their margins squeezed. Theyre earning next to nothing from lending but still need to offer depositors a rate above zero to keep their business. In Germany, the ECB has come underfor hurting the returns of savers. Central banks could run into the problem of hitting the so-called reversal rate — the point at which low borrowing costs start to harm rather than help the economy, should banks start to restrict loans. That could deepen any slowdown.

6.How did we get here?

Several of Europes central banks, otherwise unable to spur growth in the aftermath of the 2008-2009 financial crisis, cut interest ratesin 2014. Japan. The idea was to spur lending by charging financial institutions, rather than rewarding them, for parking money that otherwise could be put to use in the real economy. Since 2016, the ECBs benchmark rate has been-0.4%, meaning banks lose 4 euros to store 1,000 euros there. The sub-zero rates were supposed to be temporary but have endured. Traders arethat the ECB will push its deposit rate ever more negative this year, drivingof bond yields below zero.

7.Why have negative rates lasted so long?

More than a decade on from the credit crisis, inflation is still scarce, with wages increasing only modestly despite large drops in unemployment. The ECB, for example, isnt expected to get to its close-to-2% inflation target over the next decade, according to a market-derived measure. And the yield difference between U.S. three-month bills and 10-year Treasuries, an indication that an economic contraction may be coming. Aside from the U.S. Federal Reserve, few central banks that slashed interest rates during the credit crunch have managed to raise rates, meaning that during the next downturn they are likely to head further into negative territory.

8.Wheres all this heading?

In Europe, there are fears that the continent is following thes so-calledlost decade, where policy makers struggled to revive anemic growth and inflation. Central banks have been keen to iterate that they still have tools in their locker to combat any slowdown, including rate cuts and more quantitative easing. For markets, waningis bad for trading. Geopolitical tensions over trade, and Britains exit of the European Union will keep driving investors into the safest assets, meaning demand will remain high for negative-yielding debt. But the push to find juicier returns with riskier bets raises the prospect of furtheror a new.

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