A shrinking universe of income-producing assets for investors could heighten the investment challenge for yield-hungry pensions and insurance firms, as fears of a global slowdown and a eurozone recession drive investors into the perceived safety of bonds.
“The collapse in interest rates and [volatility] has seen the quest for yield re-emerge as the dominant investment theme,” wrote Marco Stoeckle, head of corporate credit research at Commerzbank, in a March 21 note.
Indeed, recent data show that the total amount of negative-yielding debt in bond issues represented in the Bloomberg Barclays Global Aggregate Bond Index
stood at nearly $9.7 trillion, marking a more than 50% increase from September.
That means investors are faced with an increasing pile of fixed-income assets that offer them less than their original investment.
Moreover, the unusual condition of negative rates isn’t likely to resolve itself soon and could worsen.
After a double-shot of weaker-than-expected eurozone and U.S. purchasing-managers-index readings on Friday, buying in global government paper surged, sending the yields of well-developed government debt spiraling even lower.
Indeed, the 10-year German government bond
joined the Japanese 10-year bond yield
in negative territory, while both slumped to their lowest levels since 2016, Tradeweb data show.
Bond prices rise as yields fall, and vice versa.
U.S. Treasury yields followed suit, with the 10-year benchmark rate falling around 8 basis points to 2.46% on Friday. The yield drop in the benchmark maturity briefly pushed it below the 3-month T-bill
triggering a key recession indicator — a yield-curve inversion — that experts say reveals the extent of market anxieties centered on sluggish global growth seeping into the U.S. An inversion has been an accurate predictor of recessions and investors driving shorter-dated rates above their longer-term counterparts, which defines an inversion, implies that the market participants hold a dim view of the long-term economic outlook.
Against the backdrop of growing recession fears, stock markets tumbled Friday, with the Dow Jones Industrial Average
the S&P 500 index
and the Nasdaq Composite Index
all booking their worst daily declines since Jan. 3, according to FactSet data.
It is a dynamic of meager and negative yields that has fostered a greater appetite for risk taking, writes Alberto Gallo, portfolio manager at Algebris Investments.
Gallo exemplified this best, noting in a Friday tweet that one would need to invest €10 million ($11.32 million) in 30-year German government bonds
to earn an annual income of €60,000, highlighting that investors were poorly compensated even when they bought comparatively higher-yielding, longer-dated maturities. The 30-year German bond yield trades at 0.60%, less than 2 percentage points below its equivalent American peer.
Strategists and traders say many yield-hungry investors in Japan and Europe could either look beyond low-yielding, and sometimes negative-yielding government bonds, to buy corporate bonds and arcane forms of debt such as collateralized-loan obligations, also known as CLOs.
However, market participants said there may still be good options in fixed-income, including European corporate debt, that don’t sharply and unduly ratchet up risk.
“Today’s environment calls for diversification into alternatives and into credit risks which may represent a better source of yield than sovereign credit,” wrote Gallo in a Monday research note.
“A prolonged environment of loose policy which will help to reduce tail risks for the cycle, but without fixing structural economic issues,” he said, referring to easy-money monetary policies currently being espoused by the Federal Reserve and the European Central Bank, which have both downgraded their expectations for regional economic expansion and dialed back earlier plans to normalize crisis-era policies.
Commerzbank’s Stoeckle said that “despite all the real and potential damage slowing growth and trade conflicts might create in the corporate space, investors are increasingly pushing back into” euro-denominated investment-grade and sub-investment grade corporate bonds.”
Aza Teuween, a portfolio manager for TwentyFour Asset Management, told MarketWatch that European corporate debt dynamics remain healthy because a number of companies had refinanced their debt at, or near, zero in 2016, meaning their interest costs remain muted, lowering a likelihood of default.
“Many companies don’t have need for a refinancing right now, a lot of the loan maturities in Europe are pushed to 2023 and 2024. Because spreads were so tight in 2016, every company that could refinance has refinanced. With healthy interest-coverage ratios, its difficult to see that default rate pick up,” Teuween said.
And corporate bond buyers could still benefit from further price appreciation.
Corporate credit spreads, the extra yield investors demand to be compensated for buying riskier debt over safer government paper, still remain relatively benign compared with the first half of 2018, before a combination of anxiety around Britain’s negotiations to exit from the European Union and upheaval in Italian politics sent tremors across eurozone corporate credit markets. When the price of a corporate bond rises, its yield will fall and compress its credit spread.
However, U.S. debt may still hold that greatest appeal for investors, even with Friday’s yield slide.
“There’s much less of a reason to go outside,” Ed Al-Hussainy, senior rates and currencies analyst at Columbia Threadneedle, told MarketWatch.
GDP and flurry of housing data ahead
Looking ahead, investors will watch for a final update of the fourth-quarter gross domestic product data due Thursday at 8:30 a.m. Eastern Time, which may be more closely watched amid growth worries.
On the housing front, Tuesday will see a February report on housing starts, building permits at 8:30 a.m., and the closely followed Case-Shiller home price index at 9 a.m., while on Thursday, a February report on pending home sales is due at 10 a.m.
Meanwhile, a report on current-account deficit and trade are due at 8:30 a.m. on Wednesday.
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