The bond market is in the doldrums. The value of the world’s negative yielding debt has risen to more than USD 16,000 billion, the highest level in six months. Yet not every bond investor is worried about negative yields.
Last week, the Japanese ten-year yield fell below zero for the first time since December. In Europe, the German ten-year yield fell to minus 0.51 percent, the lowest level since early February. The German 30-year interest rate also dropped below zero last week. This means that all German debt, which serves as a reference for bonds throughout the eurozone, is trading at negative yields.
Chris Iggo (photographed above), Chief Investment Officer of Core Investments at AXA Investment Managers, stated in an interview with Fondsnieuws (Investment Officer Luxembourg’s Dutch sister publication) that negative yields do not have to be an explicit problem for bond investors. It is only “an accounting problem”, he said.
For insurance companies, there will always be a demand for bonds, he clarified. “We look for investments that fit the liability profile. Bonds, including negative-yield bonds, are the investment instrument that best matches these obligations.”
“As an insurer you have obligations in the field of life insurance policies, among others. It is common practice to invest in assets with similar maturities to compensate for these liabilities. An insurance company must keep the solvency at a high level. The fact that some government bonds have slightly negative yields, we accept.”
Demand high despite negative yields
Currently, the Federal Reserve holds more treasury bonds than ever before. The combined purchases of government bonds by the Fed and large domestic commercial banks have totalled almost USD900 billion so far this year.
This was larger than the net issuance by the US Treasury. The ECB also holds 40% of the outstanding European government bond market. The percentage of freely tradable bonds has thus been significantly reduced. The fiscal stimulus and credit creation in the US have caused banks’ deposits to rise massively. Households have received cheques which have then been deposited in commercial banks.
From these increased liabilities, banks normally make loans and buy assets in the private sector. But the influx of money has become so great that they cannot issue enough loans. Commercial banks therefore have to place large parts of their balance sheets in ‘safe assets’ - government bonds.
“There is a strong demand and that demand no longer has anything to do with whether yields are at the right level. Negative yields are a ‘secondary consideration’, we see money being put to work here.”
Long-term low interest rates
Iggo does not rule out that interest rates will remain low for the next 15 years. If interest rates rise, the increase will be limited, he argued. “Rising interest rates are in fact problematic for the private sector. A government can easily finance itself but for private individuals it is more challenging”
Debts are contracted on the basis of a variable interest rate, so the cost of debt rises with rising interest rates. This has an impact on the economic situation of a company or a household.
According to Iggo, central banks are well aware of this. “If you think back to the last time we saw interest rates rise, in 2017/2018 in the US, we peaked at 3 per cent. If you go from zero to three per cent that is really significant. It only becomes really problematic when those interest rates go up to levels we saw in the 80s and 90s, but that’s not going to happen.”
The ECB is the odd man out
Unlike the US central bank and The Bank of England, the ECB is very vague about the future of its buying policy, as far as Iggo is concerned. The Bank of England has indicated that the buyback programme will be reduced if interest rates rise. The ECB has not given any “long-term guidance” he said.
“In March the PEPP (Pandemic Emergency Purchase Programme) will end but it is unclear whether quantitative easing will continue,”said Iggo. “If they wanted to do so through the APP (Asset Purchase Programme), they would face a complicated regulatory transition. Until now, monetary policy has been the answer to the economic problems in the Euro. Another option is to change the fiscal rules, but there is strong opposition from countries like the Netherlands, Germany and Finland to abandoning the Stability and Growth Pact and allowing government deficits to rise further. A strong fiscal stimulus would be created if all eurozone countries could increase their budget deficits by half a percent. Government bonds are there to finance that.”