How is fiscal policy affected by negative yielding bonds?

This morning has started with a familiar drumbeat for these times. The ten-year yield in Germany has fallen to a mere 0.022% so not only is it being paid if it issues bonds up to nine years in maturity the benchmark ten-year is on the edge of joining it.Also it is a sign o’ the times that it is now being measured in hundredths. If we move across the border to Switzerland then this happened on Wednesday. From the Financial Times.

The Swiss National Bank has announced it will be selling 13-year bonds, maturing in June 2029, with a zero per cent coupon, its lowest fixed interest rate on record…….It seems likely that investors will be prepared to buy the debt for a guaranteed loss.

Actually as a technical issue let me correct the FT as you only have a “guaranteed loss” if you hold to maturity. In the frenzied world right now you may get a short-term profit. Even if you go out some 30 years then you are struggling to get even a 0.1% yield. I note that the average yield on both German bunds and Swiss bonds is negative which means as a broad brush they are being paid to borrow overall.

Not everybody is in that boat but the ten-year UK Gilt yield dropped to a record low 1.22% and the US Treasury Note ( ten-year) has fallen to 1.67%. So as the FT tells us.

Super low and sub-zero yields, once a source of shock, are becoming a standard part of Europe’s bond markets

I am not sure why they specified Europe as the US yields are historically very low and of course the land of the rising sun or Nihon has a ten-year yield of -0.14%. Oh and speaking of Japan.

Japan PM Advisor Nakahara: Suggests Boosting JGB Purchases To JPY100 Tln Per Year -Should Increase Easing As Soon As Next Week (@livesquawk ).

Or monetary policy meet fiscal policy or if you prefer vice versa.

What about fiscal policy?

The current situation poses some new questions for fiscal policy. There have been people in favour of a fiscal boost all along or to be more accurate more of a fiscal boost as the vast majority of countries run annual deficits. But in a nutshell the past thinking was on the lines of an expansionary policy would lead to high bond yields and possibly much higher ones should it look to be getting too high. The too high was always a bit vague with no specific levels of deficit or national debt. However A threshold did exist in the past for the UK amongst others and we saw for a while the “Bond Vigilantes” sending bond yields in the countries affected by the Euro crisis much higher. It seems extraordinary now to point out that Portugal’s benchmark bonds had a yield in the mid-teens as opposed to the 3% or so that the mainstream media tells us is a crisis now.

There are several issues to this. Let me start with simple bond management where there are two impacts. The most obvious is that it is either cheap to issue or you are paid to do it. The second is a quantity one which is you will be able to sell a lot of bonds to a yield hungry world if you nudge your yields a little higher as the Bond Vigilantes turn into Pac-Men and women. Only countries perceived to be a pretty extreme crisis will be exempt from this.

A Fiscal Boost

This has become extremely fashionable and links back to my article of yesterday when I looked at a speech made by ECB President Mario Draghi.

This is why the ECB has said many times that fiscal policy should work with not against monetary policy, and the aggregate fiscal stance in the euro area is now slightly expansionary.

He is hinting at a welcome for a more expansionary policy which gets a lot clearer if you read between the lines here.

But the orientation of other policies also influences the speed with which output returns to potential. So if other policies are not aligned with monetary policy, inflation risks returning to our objective at a slower pace.

As Mario is stamping the pedal to the metal with his monetary policy he is plainly pushing for an easier fiscal stance which is of course the opposite of past ECB advice. So many central bankers seem to take the words of Margaret Thatcher “U-Turn if you want to” as a strategic plan these days don’t they?

Japan is also switching one of the tenets of Abenomics. You see the initial fiscal and monetary boost was supposed to provide such growth that everything would be better except as the FT reported at the beginning of the month.

Japan’s fiscal situation is the worst among the major industrialised economies.Its government debt exceeds 200 per cent of gross domestic product — worse than Greece.

In fact in the Abenomics fantasy world reality appears to have disappeared.

Mr Abe said during a press conference on Wednesday that he would not change a target of achieving primary balance surplus in fiscal year 2020, but how he can meet this goal is now unclear.

So a fiscal consolidation becomes a fiscal boost but don’t worry as the future is bright! Sadly like in the UK the fiscal future that is bright is 3/4 years away whenever you start from.

Germany Japan and Switzerland

These three countries could undertake a fiscal boost right now and be paid to do so. They would be better off in annual terms by doing so. Firstly let me give you some musical accompaniment to this idea from OMC.

How bizarre
How bizarre, how bizarre

There are even a couple of lines from the song for the Bond Vigilantes.

It’s making me crazy
(It’s making me crazy)

So Germany could borrow and boost the Euro area in a way that those who argue against imbalances would consider as Christmas come early. Switzerland could do the same and again boost the Euro area. Japan could join in or to be more specific it could add to its existing fiscal boost and hope that doubling-down again would work and likely be paid to do it.

GDP Linked Bonds

Jens Weidman of the German Bundesbank has highlighted this today.

zero-risk weighting of sovereign debt distorts capital allocation and therefore acts as a drag on growth…..Doing away with sovereign debt as a cluster risk would also pave the way for the orderly restructuring of sovereign debt

At first sight he is saying how silly the current situation is although avoiding the fact that the ECB of which he is (mostly) a voting member has driven it both theoretically and practically. So the suggestion is as follows.

A recent initiative by the Bank of England is pushing for the introduction of standardised GDP-linked bonds. By tying coupon payments, and potentially the principal as well, to a country’s growth rate, investors share both the upside and the downside risk of a country’s economic development.

You may recall this was suggested for Greece back in the day and investors can let out a sigh of relief it never happened as the ongoing economic depression would have made their investments take an ice bath. For Germany right now it would not far off define insanity but there are problems. The Bank Underground blog unwittingly helps us out.

rewriting-history-understanding-revisions-to-uk-gdp

What could go wrong?

Let me throw in another problem which is changes to GDP itself. In the last few years the UK has made several by changing its inflation definition ( worth around 0.5% per annum of “extra” growth) and the ESA 10 changes such as drugs and hookers as well as double counting Research & Development which was worth around 4%. A nice windfall for those in the know?

Comment

Negative yielding bonds provide quite a windfall for fiscal policy. There is a flow one which the media mostly ignores but there is the opportunity for a capital one should the 3 main beneficiaries use it. It is not quite a “free lunch” although it would be for a while a lunch that you were paid to eat. What I mean by that is that the national debts would rise and also the bonds would as a minimum have to be refinanced in the future and maybe in some sort of alternative universe – the sort of place where Spock in Star Trek has emotions – be actually repaid.

So thoughts?