The idea of loaning a government money for no return is absurd. But that’s what’s happening in five European countries, and at some multi-nationals.
Investors have been loaning them money for next to nothing, and in some cases even paying for the privilege of buying up the debt.
So-called negative yields have been creeping across Europe for years now. There is now a staggering $11.7 trillion of bonds with negative yields – a figure that has already surged 12 per cent in the brief post-Brexit period, according to Fitch Ratings.
The growth of investments which people pay to own is “one of the biggest conundrums facing investors”, says Russ Mould, investment director at AJ Bell.
Last week there was a fresh landmark, when a UK government bond, or gilt, maturing in 2018 traded at minus 0.003 per cent, negative for the first time.
It came after ratings agencies downgraded the status of UK government debt. Bond yields move inversely to prices, so pushing yields lower reflects a sense of fear about the outlook. Yields on US government debt also hit a record low last week, reportedly driven by panic buying from Europe.
The UK’s negative moment followed a hint from governor Mark Carney that he may begin stimulus measures, to ease the pressure on the economy while the ramifications of the referendum play out.
“The irony of the Brexit vote is that since then [we] have become more like Europe, not less,” says Adrian Hull of Kames Capital.
It was a stark reminder of the uncertainties ahead for the UK, and how investors have been clamouring for safer places to park their cash.
“Why would people effectively pay to lend money to a government, when in the normal world of finance, you get paid with interest if you lend? [It’s because] investors are more interested in getting their money back than the return they get on it,” says Simon Smith, chief economist at FxPro.
With developed economy stock markets hovering around record highs and asset bubbles appearing in everything from property to technology, bonds seem like a decent alternative, even if they pay out peanuts. “People are being forced into this,” says Peter Toogood, investment director of City Financial.
The trend is also being driven by the European Central Bank, which has started charging banks to hold deposits with it. The ECB has also been buying up €80bn a month of government debt from across the Eurozone. It’s ostensibly a way to support regional governments.
Bonds from the “safest” countries are yielding below zero, and while a lot of hubbub has been made of the negative levels, it could just be the start. “The ECB has said it will buy corporate bonds up to yields of minus 0.40. So when we all thought zero was the floor, they have changed that and minus 0.40 is the new zero,” says Hull.
The problem is the distorting effect this has on everything else. Investors keep a close eye on future yields, and what they show about market expectations. Low bond yields stretching out into the future – on a graph known as the yield curve – tend to portend a period of slow growth, and at these levels, they’re forecasting recession.
“There is no way this can ever be considered a positive,” says Toogood, adding the yield curve shows recession is on the cards in the US at least.
“It has been the best economic indicator and it has never, ever, been wrong.”
Banks are also likely to find things tougher. “The real implications are for the banks and the rest of the economy. Banks make money by borrowing short and lending long,” says Hull. The lower the interest rates on loans, the less chance banks have of profit making.
Negative yields also put pension funds under pressure. Bonds are “in theory a source of steady coupons in return for taking limited risk”, says Bell, and have been favoured by pension funds, which need lower-risk investments.
But if a great swathe of bonds aren’t paying anything, how will pension funds make sufficient returns on suitably risky investments, to match their members’ needs? In some cases, negative yielding bonds can give a positive real return, but not always. Fundamentally, the role of bonds as an investment is changing and it warrants a reappraisal by investors.
“This will have a massive and negative effect on most pension scheme’s funding plans,” says Warren Firth, actuarial director at Broadstone.
Companies with defined benefit schemes are also going to be under the cosh as they work out how to match investment returns with liabilities.
“It’s going to be a drag on growth as companies have to allocate resources to pension funds rather than into their own businesses,” says Hull. “There’s no doubt these low yields are a real problem for pension liabilities. It will put pressure on any company that has a defined benefit scheme. They’re under-funded and this will exacerbate that.”