Global investment markets are now subject to record-breaking levels of negative yielding debt.
The current tally stands at around $16trn (€14.4trn) worldwide – much higher than in 2015-2016, when the world economy teetered on the brink of recession – and this figure has ballooned rapidly since last October, when it stood at just $6trn.
Negative yielding debt has ballooned in recent months
Bonds which offer a negative yield effectively equate to lenders paying borrowers for the privilege of giving out their capital, if these bonds are held to maturity.
“Negative yielding debt has quickly become a new normal, which is a staggering place to find ourselves,” said David Absolon, investment director at Heartwood Investment Management, the UK asset management arm of Sweden’s Handelsbanken.
Negative yielding debt has been on the rise for three reasons, according to Absolon.
“First, global central banks are currently engaged in a concerted effort to support the global economy. Interest rate cuts across the developed world, and most crucially at the US Federal Reserve have encouraged extraordinarily low bond yields,” he said.
“The market has also been driven by hints at further accommodative central bank action ahead, including from the European Central Bank (ECB).
“Second, while certain drivers of growth in the global economy – such as the buoyancy of the US consumer – have been robust, weak economic data overall has given investment markets cause for concern.
“Growing unease has led to a flight to safe haven assets like government bonds, as continued fears around global growth push wary investors to preserve as much capital as possible at all costs,” Absolon added.
“Third, inflation expectations have fallen considerably, making negative yielding debt look relatively less risky.”
Risks to investors
A key feature of this raft of negative yielding debt is the participation of the corporate sector.
The corporate bond market now accounts for $1.6trn (€1.4trn) of negative yielding debt globally, and Europe is a big proportion of that. Of this global total, $1.1trn belongs to the financial sector, with the balance made up by non-financial sectors, including 14 eurozone non-investment-grade companies (such as Nokia).
Negative yielding corporate debt levels in Europe are substantial, and rising
While the level of negative yielding debt is new, an environment of lower yields has existed for some time.
Businesses have naturally been incentivised to take advantage of this environment to reduce the cost of servicing their debts, and many have been able to opportunistically extend the maturity of these debts at a time to suit them.
However, a trend for issuing short-term – 12-18 month – debt, which has ramped up in 2019, may pose a significant risk to issuers, who cannot now be creative about when to refinance.
These businesses must accept whatever lending conditions are in situ when their near-term debt matures, which could be punitive if the landscape changes quickly.
“The greatest risks may be reserved for bond market investors. Investors who believe that long-term yields will continue to fall may see negative yielding debt as a case of better the devil you know,” Absolon said.
“But given that bond yields are intended to compensate investors for the risks they take in lending out their capital, in buying negative yielding debt, investors are effectively pricing in no credit risk or interest rate risk for the duration of the bond they are buying.
“In places where cash itself offers a negative return – such as the eurozone, where the ECB has set negative interest rates in an effort to stimulate the stuttering economy – negative yielding bonds may appear less risky on a relative basis.
“In Europe, positive yields are only available on 30-year-plus bonds in some countries, meaning that investors must take on substantial interest rate risk for still only minimal yield,” Absolon added.
A global phenomenon?
While historically lower bond yields are in evidence across the globe, negative yielding debt is not, particularly in the developed market space.
Between Brexit, the 2018 US tax break sugar rush, and Europe’s decidedly shaky economy, yields in these regions have diverged materially.
In the UK, where economic fundamentals are currently challenged given the fog of Brexit, yet where inflation expectations are fairly solid, debt markets are still conducting themselves in a relatively orderly fashion.
Though low, UK government debt remains positive-yielding, with investors still being paid to take on risk. Meanwhile, in UK corporate debt markets, ongoing uncertainty surrounding the seemingly eternal Brexit debacle is still encouraging positive yields in an orderly fashion across short- and long-dated debt.
In Europe, where the central bank is keen to do more to stimulate economic activity, negative yielding debt is likely to increase in the short to medium term. This is because the ECB itself will likely soon begin buying sovereign and corporate debt again, pushing yields even further into negative territory.
“Not all debt in Europe is being issued with negative yields. Notably, asset-backed securities in the region are offering positive yields and yields on eurozone financial corporate debt are also comparatively high, with banks compensating investors for taking on higher credit risk,” Absolon said.
“Globally, emerging market debt can also offer compelling levels of yield, both in an absolute and relative sense.”
Future-proofing portfolios
Absolon continued: “In the worst-case scenario, where the current unease in the global economy develops into recessionary conditions, central banks would very likely slash interest rates and enact more quantitative easing.
“These actions would lead to a further rise in the amount of negative yielding debt globally, as well as a further collapse in yield curves – meaning that investors would require disproportionately higher compensation for short-term lending relative to long-term lending, reflecting significant near-term uncertainty.
“However, in other circumstances, while negative yielding debt is here to stay, the amount of debt trading at these levels could fall quite quickly.
“Good news on US-China trading relations, for example, would likely provide an instant relief for the global economy, offering encouragement to nervous investors and comfort to anxious central banks,” he added.
