Germany has now joined several of its peers around the world: the country’s benchmark 10-year Bund yield has fallen into negative territory. After trading at a near-zero yield for months, Tuesday saw the yield on German sovereign debt drop to -0.01% out 10 years.
Surprisingly, even with such abysmal yields, investors have continued to pile into these German Bunds as a safe haven. This no doubt speaks to the shocking degree of volatility and uncertainty in the markets if people are willing to pay Bundesbank (the German central bank) one basis point just to hold their money.
Bracing for Brexit
The factor looming largest in this new development in German Bunds is no doubt the anxiety caused by the increasing likelihood that Britain, one of the leaders in world trade, will vote to leave the European Union in a referendum on June 23rd. Growing support from British officials and the media for a “Leave” vote have only made this unprecedented move more plausible.
Although Britain is not part of the eurozone by retaining the pound sterling as its currency, its political membership in the EU still plays a large role in defining the economic relationship between the continent and the U.K. All of these favorable trade arrangements would be in jeopardy if a Brexit comes to pass, potentially disrupting business across Europe.
Shaking Up Investments
With the actual referendum on Brexit still more than a week out, the immediate consequences of all of this anxiety has been tumbling stocks. All 19 sectors of the benchmark EURO STOXX 600 fell while volatility jumped a noticeable 6.3%. This was also true of emerging markets: the MSCI Emerging Markets Index lost 4.7% in just four trading days.
Beyond surprising demand for the 10-year German Bund (in spite of its now-negative yield), the Japanese yen is also seeing its traditional safe haven demand in the currency markets. This is almost equally surprising given the stagnation of the Japanese economy an the Bank of Japan’s (BOJ) propensity to devalue its currency. Meanwhile, the British pound continues to sink to its lowest level since late April.
Influencing the Fed
Another aspect of monetary policy being impacted by the Brexit possibility has been the Federal Reserve’s supposed plan to normalize interest rates. As economic growth appeared to pick up earlier this year and Fed officials began issuing more confident, hawkish statements, the odds of an imminent rate hike from the central bank rose—as high as 74% by December’s meeting at the end of May. Now, the implied odds of a move by the Fed in December has crumbled to less than 50%.
In the more immediate future, the chances appear to be little-to-none for a June or July rate hike. With the FOMC’s November meeting scheduled just days before the presidential election, a move in November seems equally unlikely. That leaves September as the most likely—and perhaps only—chance for the Federal Reserve to increase interest rates at all this year.
Although the Treasury market hasn’t fallen into negative territory like Japan, Europe, Switzerland, and now Germany, the writing is on the wall. The Bund is widely viewed as one of the safest sovereign bonds due to the strength of the German economy. The same logic underpins Treasurys, which are now yielding just 1.60% ten years out. The less attractive that government bonds become, the more investors will turn toward gold as an alternative safe haven.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.