The last week or so has seen quite a change in world bond markets. We had got used to yields plunging and prices rising as more and more sovereign bond yields went into negative territory. Indeed we even saw two Euro area corporate bonds issued at negative yields as investors paid to own bonds issued by Henkel and Sanofi. This was because of a situation described like this by the Financial Times.
It was a first. It was exciting.
From Morgan Stanley, with our emphasis:
We estimate that a total of €467bln of EUR IG bonds now have sub-zero yields. Of this, €313bln of bonds are iBoxx index-eligible, split 39% and 61% between financials and nonfinancials. Thus, ~25% of the EUR IG index is now in negative yield territory, with the concentration increasing to 33% in the CSPP-eligible universe.
CSPP is the corporate bond purchase program of the European Central Bank about which we will be updated later but as of last week totalled some 20.5 billion Euros. Oh and by IG they mean Investment Grade.
Such moves are of course on the back of the various bond purchase programs of several of the world’s major central banks. The scale of the purchases was highlighted in the ECB press conference as Mario Draghi was asked this.
Does this include also the capital key, or would you argue that changes to the capital key are politically too sensitive to really discuss them?
The capital key is an issue for the ECB because it is buying the sovereign bonds of a number of different nations or as Paul Hardcastle put it.
Ninininininininininin 19 nininininninin 19
There are obvious issues when you are buying the bonds of Spain and Italy who are currently breaking the fiscal rules and the arrangement is that bonds are bought in proportion to each country’s stake in the ECB’s capital. The problem as yields fell was that the ECB could run out of German bonds to buy as so many of them were below the -0.4% Deposit Rate threshold.
However the ECB is continuing with this.
Regarding non-standard monetary policy measures, we confirm that the monthly asset purchases of €80 billion are intended to run until the end of March 2017, or beyond, if necessary,
Meanwhile the Bank of Japan is doing this.
The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen…… The average remaining maturity of the Bank’s JGB purchases will be about 7-12 years.
Much nearer to home for me the Bank of England has recently rejoined the party.
On 4 August 2016 the MPC voted to increase the stock of purchases of UK government bonds by the APF to £435bn. In addition, the MPC voted to make up to £10bn of purchases of corporate bonds over 18 months
It operates under a different structure where it buys in particular maturity zones so for example this afternoon it will purchase some £1.17 billion of UK Gilts out to the 2023 maturity.
We got used to a litany of record lows for bond yields and record highs for prices. If you think about it sovereign bonds which are supposed to be low risk heading towards 200 against a nominal value of 100 does pose serious questions.
There have been clear casualties from all of this and if we look back over the period of lower bond yields we see that defined benefit pension schemes in the UK have been an example. Mercer have pointed out this earlier today.
To put this into context, since 2010, companies have contributed an estimated £75 billion of cash (almost 5% of the value of the liabilities) but in that time we have seen no material improvement in funding levels.
More fuel for my arguments that QE can adversely affect the economy which is a antidote to the rhetoric of the central bankers and I also not this.
Consequently, pension scheme liabilities now represent 40% of the market capitalisation of FTSE 350 companies compared to 30% at the end of 2010 . This demonstrates the way in which the finances of pension schemes have grown in importance in relation to the overall size of UK companies.
Are you still wondering why companies are not investing? Oh and in case Andy Haldane of the Bank of England is making a sorely needed effort to learn a little more about the world here is an update on the pension he claims not to understand.
the latest figures show the Bank of England’s gold-plated scheme has edged into fully funded status.
the Bank had increased contributions to 54.6 per cent of members’ pensionable salary in March 2015, up from 51.8 per cent in 2014 and 24 per cent in 2011.
So Andy and his colleagues are all right Jack ( and Jill).
This issue of more and more people questioning QE is a serious one and it has led to a change in the zeitgeist and beyond. The Bank of Japan changes its story nearly every day and even the Japanese owned Financial Times is on the case. Mario Draghi raised his rhetoric to frankly ridiculous levels as he told the press corps this on Thursday.
right now the transmission mechanism is really working very well. It’s never worked better.
Tell that to the unemployed.
Bond Yields rise
Whilst we were seeing what the FT above called “exciting” ( I know they have a nice cake trolley but they should get out of that building by Blackfriars Bridge more….) there were rumblings of ch-ch-changes. As ever they began in Japan where in spite of the Tokyo Whale yields began to rise. If we look at the ten-year yield we see that it did not quite make -0.3% in July and since then has been rising and today nearly made 0%.
Germany has seen its ten-year bund yield rise from negative territory as it follows the same themes and today it has gone positive. This has generated not a few “its doubled” tweets as it has gone from 0.1% to 0.2% to 0.4% which shows that as ever with statistics and numbers care is needed. In some ways the changes are minor but there is something significant. Let us switch from what are small yield changes to big capital ones and let me illustrate from Japan.
As you can see the situation is very different if we think of potential capital losses on longer-dated bonds. The 15% loss assumes of course that someone invested at the top. Sadly we know from the past that this does happen and incidents such as the collapse of Long Term Capital Management with its Nobel Prize winners on board shows us how dangerous it can be. The financial and economic world is much more highly strung and indeed wired that it was back then.
Ireland and Belgium both sold 100 year bonds this summer with Ireland issuing its at a yield of 2.35%. Imagine the impact on them if yields backed up more? Or a pension fund cutting its losses and buying bonds right at the top…
Here is an estimate of what this might cost.
There is much to consider here and the issue of changes being minor is the actual yield or interest-rate change where for example Japan and Germany can still issue bonds for pretty much nothing. Even in the UK the ten-year Gilt has gone from just over 0.5% at the nadir to 0.88% as I type this. On the scale of the drop this is not far off a pin prick.
However when we move to capital changes as I have highlighted above the situation is very different especially if someone cut their losses or invested at the top. Also officially government bonds are low risk now please long again at the Japanese equity bond comparison above where bonds are moving much more than equities.
This might be a type of taper tantrum but there are dangers in it should it continue in another sign of how little recovery we have actually had. Also it is my opinion that Mario Draghi and the ECB wanted this and behaved in such a manner on Thursday to get bond markets to fall and ease their capital key problem. That is a dangerous game as not everything can be centrally planned and controlled and they may yet find that they are holding a tiger by the tail.