Europe's Most Important Bond Edges Back Toward Negative Territory
By Avantika Chilkoti
Investors have driven the eurozone's most closely followed government bond yield close to negative territory for the first time since 2016, underscoring the increasingly bleak outlook for the European economy.
Germany's 10-year government bonds, known as bunds, yielded as little as 0.04% on Friday, a microscopic return for investors and the lowest level since October 2016 when the region was still emerging from a protracted sovereign-debt crisis.
Sending the yields lower last week were fears that Europe's economy has slipped back into slow-growth mode, exacerbated by slack demand for European goods abroad and political gridlock at home. The European Central Bank slashed its growth forecasts for this year to 1.1% from 1.7%, and all but ruled out raising its benchmark interest rate, currently negative, before the start of next decade at the earliest.
"We're not going to do any monetary policy normalization for the next two years," said Samy Chaar, chief economist for fund manager and private bank Lombard Odier in Geneva. "All open economies have hit a brick wall," he added.
The realization that negative policy rates are here to stay led investors to pile into bunds and other low-risk government bonds. Beyond Germany, the yield on equivalent French debt drifted to 0.413% on Friday, also its lowest since 2016. That has sent borrowing costs for European corporations lower as well, with the ICE Bank of America Merrill Lynch Europe index yield dipping below 5%, from 5.5% at the end of last year.
Shorter-term European government bonds never emerged from negative territory after the ECB first experimented with below-zero policy rates in 2016 as a way to dislodge the economy from persistently slow growth. Over 22% of overall debt in the world is still negatively yielding, up from 13% at the beginning of 2016. Japan, Switzerland and Denmark also have negative interest rates.
"Most of the yield curve is already under water," said Peter Dixon, an economist at Commerzbank. "The ten-year is the last tip of the iceberg." He added: "The simple fact is that you're paying the government to take on their debt."
Investors buy negative yielding debt in some cases because they have no other choice. Bond funds follow indexes that include the bonds. Long-term holders like insurers need the bonds to keep capital safe in order to pay expected liabilities. And large bank depositors may find paying the negative interest rate is less than the charges to keep cash as a bank deposit.
Investors can also gain on negatively yielding debt if yields continue to go even lower, as the price of the bond increases inversely to the yield. Such capital appreciate trades were highly profitably in early 2016, when the ECB first unveiled negative rates.
Sub-zero yields have weighed particularly on the region's banks, which make money by lending money at a greater interest rate than is paid to borrowers. In sign that investors remain skeptical about their profitability, the Euro Stoxx Bank index trades for just 60% of the underlying banks' book value. Almost all big U.S. banks, which enjoy a positive rate-environment, all trade for more than book value.
Germany is seen as an investor safe haven thanks to the government's strong fiscal position. It has enjoyed lower rates than EU peers for years. It runs a budget surplus and its debt as a percentage of the size of the economy has fallen in the past few years, even as it has risen for France and Italy.
"The fact that you have got this expansionary budget being run in Italy and in France increases the preference for German debt for people that are quite risk averse," said David Slater, a portfolio manager at Trium Capital, the London hedge fund.
Germany bonds are also a scarce commodity. It and the Netherlands are the only AAA-rated government debt in the eurozone notes Lyn Graham-Taylor, fixed-income strategist at Rabobank. European regulations force banks and insurance companies to stock up on the relatively safe assets.
"It is fundamentally that the proportion of AAA assets in the eurozone is out of whack with what is required by the size of the economy," Mr. Taylor said.
Write to Avantika Chilkoti at Avantika.Chilkoti@wsj.com