A feature of these times has been the way that the initial cuts in interest-rates undertaken by central banks were some years later followed by a second wave especially for countries in and neighbouring the Euro area. This plunged many of them into the icy cold waters of negative interest-rates. Regular readers of this blog will not be surprised to see rumours of their being another member of this club as its central bank Governor is a “dedicated follower of fashion”. From the Financial Times and the emphasis is mine.
UK government bonds are enjoying the best start to the year since 2001 as a succession of poor economic data releases chip away at confidence in the recovery, raising market speculation that the UK may need to cut interest rates this year.
I have to confess I did wonder if they would point out that I have been warning about this for a couple of years now but I guess that would be embarrassing for all the “experts” they have quoted and given airtime and space to over that period. However more importantly there is another consequence of this.
In early Monday trade, the yield on 10-year Gilts was at 1.37 per cent, just above February’s record low
That is for someone who has followed such things for over two decades is simply extraordinary. There was a time I recall the long Gilt yielding 15% although back then the maturity was more like 15/20 years than the modern 10. But as we have discussed on here before this poses all sorts of questions for the long-term business models of pensions and insurance companies. It is hard not to think of the pensions illustration posted in the comments here by Andy Z with an illustration of -3% per annum or losses and quite considerable ones at that.
Negative Bond Yields in the Euro area
It is not only official interest-rates that are negative here as the 80 billion Euros a month of ECB (European Central Bank) bond buying has driven many bond yields and longer term interest-rates negative as well. Bloomberg puts it like this.
The driving force behind the bond binge is the growing universe of negative-yielding securities, which has expanded above $9 trillion since the European Central Bank and Bank of Japan cut interest rates below zero.
The German bond market has negative yields out to the nine-year maturity and if we switch to fast growing Ireland I note that the ten-year yield of 0.77% looks a bit thin to say the least compared to annual economic growth of 7.8% (GDP) or 5.7% (GNP). However there has been another consequence as the ECB starts to chomp away on Corporate Bonds too.
What could go wrong? Well at least part of that is what I will look at next. Although of course the obvious issue is simply one of mispricing rather like the AAA rated Mortgage Backed Securities which did so much to get us into this mess.
The problems of pension funds and insurance companies
The President of the Bundesanstalt für Finanzdienstleistungsaufsicht weighed in on the subject last week and with a name like that it has to be Germany, fortunately it shortens to BaFin.
Institutions which primarily based their business models on interest income and maturity transformation were having increasing difficulty generating sufficient income in the long term.
If we look at occupational pension funds this was stated.
However,Pensionskassen (occupational pension schemes) were suffering even more than life insurers from the low interest rates. In individual cases, they might soon be unable to provide their benefits in full using their own resources.
So they will soon be unable to pay out the benefits their pensioners expect. Many of them will no doubt consider these to have been guaranteed. Is “using their own resources” a cry for help and from who exactly? With Mario Draghi setting out ECB policy into the next decade and implying negative interest-rates and yields then there is little if any sign of relief on the horizon.
Actually there is an excellent reply to this in the comments section of the FT.
Wasn’t the Greek the one wasting money into a crazy pension system ? Ah, no: it’s the German. LOL. ( Musso)
Actually though the Germans are not alone.
Bafin’s comments come just two weeks after the head of France’s largest public pension fund warned many retirement funds in Europe will “implode” if the ECB’s low interest rate policy continues.
Probably not the sort of implosion seen at Old Trafford or indeed St. James Park yesterday but nonetheless not something to help pensioners sleep at night. I have written before about issues with the Dutch pension system ( there were cuts in 2013 if I recall correctly) and they too are in this club.
ABP, Europe’s largest retirement fund, which provides pensions for one-sixth of the Dutch population, also said last month there is a “distinct possibility” of benefits being cut in 2017 due to declining interest rates.
According to Exactica ABP is in what Taylor Swift would call “trouble,trouble,trouble….”
By law, a pension fund must have a coverage ratio of 105%, meaning its assets outweigh its obligations by 5%. However, that of the massive civil service fund ABP has now gone down to 90.4%, a drop of seven percentage points since the end of 2015.
That poses a few questions as after all is not the QE of the ECB supposed to be driving asset prices higher. If so how are they falling? After all bond prices are in many cases as high as they have ever been.
There is a reply to this saying “Deal with it” as I wonder if it was written by Mario Draghi.
Never believe anything until it is officially denied
We have learnt that one of the signals of a serious problem is an official denial of it and here it is from mouth of Mario Draghi.
It’s pretty evident that pension funds and insurance companies and other actors are significantly affected by the low-level of interest rates. By the way, I would urge all the actors in this sector to resist the temptation to blame low interest rates as the cause of everything that went wrong and had been going wrong for years with this sector.
So Mario was shifting the blame along the lines of “It’s not me, It’s you” from Lilly Allen. I do note that he went on to confess both borrowing from the future and can-kicking.
one should keep in mind that they also realised substantial capital gains on the bonds that we are buying, because some of them are amongst the main sellers,
These asset prices seem to be simultaneously high and low! Of course there are other assets excluding bonds but QE was supposed to be boosting them too. Oh and his excuse that in the US pension funds have seen zero rates for longer needed to be challenged by the fact that they have not seen negative ones yet.
Insurance Companies too
These are also being affected by negative yields and interest-rates although Bafin seems to have confused itself on this subject.
the low level of interest rates was weighing on life insurers, but said that BaFin could not currently confirm that undertakings, even smaller ones, were increasingly turning to risky assets to be able to fulfil their guarantee commitments.
I think we all can answer that one for them!
We are now seeing the consequences of the “more,more,more” policies of the central banks as they find themselves reaching a future that is not as good as promised or hoped. If we look at the Euro area it has just had a better start of 2016 (0.5% GDP growth) but sadly recent years have disappointed. Of course much of the fault lies with the politicians who have pretty much left economic policy to the ECB which has often found itself to be the only player in town. But like a one club golfer there are consequent problems.
Pretty much every long-term business model in the arena of finance is broken right now as they rely on a level of yields that no longer exists. Actually we find ourselves wonder if even the longest dated bonds may have their own outbreak of negativity as Japan on Thursday issued a 30 year bond offering only 0.33%. Great for the Japanese taxpayer but dreadful for the buyer in my view. Is yet another bailout on the way?
Meanwhile I note in the BaFin report confirmation of the banks operating for the benefit of the banks in spite of all the supposed new regulation.
BaFin wanted to find out whether banks and savings banks were systematically disadvantaging customers by unreasonably delaying the passing along of interest rate changes on consumer loans to them.
Oh and American readers may not be quite as comfortable as they might have thought as perhaps Mario Draghi will be right.
I would not completely rule out the use of negative interest rates in some future very adverse scenario, ( a letter to a Congressman from Janet Yellen)
I thought they were supposed to be illegal in the US?