It’s not just the unprecedented low yields on sovereign debt that is plaguing the credit markets. Corporate bonds are likewise stuck in negative territory in many cases, confounding investors’ attempts to eke out some meager return while parking their money in a supposedly safe place.
The bond markets are responding to an all-out contagion of subzero interest rates. Worst of all, this has spurred many investors to chase yields in extremely risky assets like junk bonds—extremely low-rated corporate debt.
The market for corporate bonds is closely tied to underlying trends in U.S. Treasurys (or the sovereign debt of that company’s home country). In most cases, they will offer yields that are just ever-so-slightly higher than the government bonds in order to entice investors.
So, naturally, the corporate bond market (in Europe, at least) has followed government bonds into negative territory. According to Bloomberg, “Deutsche Bahn AG last week became the first non-financial company to sell sub-zero euro notes. The German railroad issued 350 million euros of five-year bonds to yield minus 0.006 percent.”
Negative-yielding corporate bonds are still relatively attractive to European investors because they aren’t as far negative as the sovereign bonds issued by Switzerland and the ECB, among others. In this way, the argument for holding zero-yielding gold is especially pertinent, flip-flopping the prevailing logic that holding gold was pointless because it offered no yield. When everything else has subzero yields, no yield is a net gain.
Moreover, even “junk” assets are now offering measly yields to investors, following the rest of the markets lower. A pair of Credit Suisse analysts noted, “any hunt for yield over the past 2.5 years as a whole has been an unsuccessful strategy.”
Another key component to the apparent demise of the bond markets is the unprecedented level of risk that investors in this supposedly safe debt are now facing. Rather than pricing them at their current face value, traders are swapping securities for what they believe someone might pay for them in the future. This type of market behavior is “dangerous,” according to JPMorgan’s managing director of its asset management division, Oksana Aronov.
Nominally, the yield on benchmark 10-year U.S. Treasurys has risen about 20 basis points back to 1.57% from a low of 1.37% earlier this month. When you account for inflation (rather than relying on the nominal yield of bonds), 10-year T-notes are actually offering negative real yields. This actually ranks behind Japan’s government bonds of the same duration, and is approaching the lowest real yield on U.S. debt in over 35 years. While speaking with Bloomberg TV, Ms. Aronov characterizes the current bond market this way: “the risks are, frankly, unprecedented.”
Under such conditions, it is highly unlikely that the Federal Reserve will take the added risk of hiking interest rates anytime soon. Every so often, usually after some favorable report on unemployment or a momentary spike in the pace of the economy, the whispers that the Fed is preparing to raise rates will resurface. However, given the shaky atmosphere of persistently slow global growth, expect the central bank to remain very cautious in an attempt not to upset the fragile bond market.
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.