European Bond Markets Go Down the Rabbit Hole
Bond market is increasingly challenging fundamental tenets of investing
By Richard Barley
Updated April 13, 2015 6:43 a.m. ET
Europe is no stranger to the avant-garde, the experimental and the absurd. But until now, they have largely been the preserve of the arts. Now the financial world—and in particular the bond market—is increasingly challenging fundamental tenets of investing.
Take last week as an example. Switzerland became the first sovereign to issue a 10-year bond carrying a negative yield, raising 232.5 million Swiss francs ($237.2 million) with investors paying for the privilege of lending. Mexico followed with a 100-year €1.5 billion bond that was swiftly snapped up. By Friday the price of the bond had risen five points, and it was yielding less than 4%. In the eurozone, French five-year yields turned negative. And German yields continued to grind deeper into negative territory: yields on eight-year bonds briefly dipped below zero, while the two-year yield stands at minus 0.277%.
Any of these events would be noteworthy in and of themselves; that they all occurred within a week speaks to the highly unusual situation bond investors find themselves in. Increasingly, the time value of money, a core concept, seems to count for little. That leaves the market faced with questions that, not so long ago, would have seemed ridiculous.
Any of these events would be noteworthy in and of themselves; that they all occurred within a week speaks to the highly unusual situation bond investors find themselves in. Increasingly, the time value of money, a core concept, seems to count for little. That leaves the market faced with questions that, not so long ago, would have seemed ridiculous.
For instance: can German 10-year yields turn negative? There seems no reason to believe they can’t: the zero bound has ceased to exist. Previous targets for low yields that were dismissed as unrealistic have come and gone, and German securities have continued to rally. A year ago, 10-year yields stood at 1.53%; they are now around one-tenth of that level, at 0.16%. The European Central Bank’s quantitative easing program, coming at a time when the German budget is balanced, is creating a scarcity of paper. The rise in government-bond yields expected by some—a feature of quantitative-easing programs in the U.S. and U.K.--has failed to materialize.
This week the ECB is likely to face more questions about its purchase program, under which it aims to buy €60 billion of bonds a month. The debate here has swung quickly from wondering whether ECB QE would be good enough to whether it is too effective. It has certainly made a splash: The average 10-year yield for Germany, France, Italy and Spain, weighted by the size of their economies, has fallen to just 0.61%, from around 1% at the start of the year. Meanwhile, eurozone economic data have put in a surprisingly strong showing, led by an apparent consumer revival—although inflation is still far off the ECB’s target of “below, but close to” 2%.
But given that the ECB has only just started on a program that is intended to run until September 2016, it seems likely that President Mario Draghi will bat away any questions about changing tack.
For European bond investors, that means more bond-market curiosities probably lie ahead.
The absurd is becoming an everyday occurrence. All the more reason for investors to keep one foot anchored in the real financial world.
Any of these events would be noteworthy in and of themselves; that they all occurred within a week speaks to the highly unusual situation bond investors find themselves in. Increasingly, the time value of money, a core concept, seems to count for little. That leaves the market faced with questions that, not so long ago, would have seemed ridiculous.
For instance: can German 10-year yields turn negative? There seems no reason to believe they can’t: the zero bound has ceased to exist. Previous targets for low yields that were dismissed as unrealistic have come and gone, and German securities have continued to rally. A year ago, 10-year yields stood at 1.53%; they are now around one-tenth of that level, at 0.16%. The European Central Bank’s quantitative easing program, coming at a time when the German budget is balanced, is creating a scarcity of paper. The rise in government-bond yields expected by some—a feature of quantitative-easing programs in the U.S. and U.K.--has failed to materialize.
This week the ECB is likely to face more questions about its purchase program, under which it aims to buy €60 billion of bonds a month. The debate here has swung quickly from wondering whether ECB QE would be good enough to whether it is too effective. It has certainly made a splash: The average 10-year yield for Germany, France, Italy and Spain, weighted by the size of their economies, has fallen to just 0.61%, from around 1% at the start of the year. Meanwhile, eurozone economic data have put in a surprisingly strong showing, led by an apparent consumer revival—although inflation is still far off the ECB’s target of “below, but close to” 2%.
But given that the ECB has only just started on a program that is intended to run until September 2016, it seems likely that President Mario Draghi will bat away any questions about changing tack.
For European bond investors, that means more bond-market curiosities probably lie ahead.
The absurd is becoming an everyday occurrence. All the more reason for investors to keep one foot anchored in the real financial world.
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