Bloomberg Businessweek - USA (2019-07-29)

◼ FINANCE Bloomberg Businessweek July 29, 2019

22

corporate bonds provide. Large investors such as

pension funds, insurers, and financial institutions

may have few other safe places to store their wealth.

Monetary authorities have brought down bond

yields by keeping key interest rates exceptionally

low since the financial crisis ④, with the aim of spur-

ring borrowing that would lead to economic growth.

After the ECB cut its deposit rate below zero in 2014—

central banks are able to actually charge banks to

hold their money—several of Europe’s other mone-

tary authorities also introduced negative rates. The

Bank of Japan soon followed, although it was already

a trailblazer when it adopted zero interest rates two

decades ago. Central banks also helped push rates

down by embarking on purchases of longer-term

debt, in what became known as quantitative easing.

Central bankers are reacting to broader eco-

nomic forces. One reason they typically raise rates

is to curb inflation. But prices haven’t been shoot-

ing upward, and gauges of the market’s inflation

expectations ⑤ show there’s little on the horizon.

Particularly in Japan, persistent fears of deflation—

falling prices—can make negative yields seem like

a reasonable deal. Inflation generally goes hand in

hand with a strong economy. While central bankers

have been trying to stimulate growth, some govern-

ments have been more conservative. Take Germany:

Even though the bond market is willing to pay the

country to borrow, the government has been reluc-

tant to jeopardize its budget surplus.

One theory is that demographic forces ⑥ will

keep inflation and rates permanently low. Europe

is thought to be going through a process that’s

already played out in Japan—as populations get older

and the share of working-age people falls, there

may be too little consumer demand pushing prices

up. Meanwhile, pension funds are willing to pay

up for long-dated bonds—and accept low yields—to

THEBOTTOMLINE Negativeyieldsonsomebondsaroundthe

world are reducing the cost of all kinds of debt. That’s good for

borrowers and should help growth, but it also spurs risk-taking.

match their increased retirement liabilities.

Ultralow rates on the safest bonds have had

a spillover effect on other markets. A handful

of corporate junk bonds denominated in euros

havenegativeyields.Investorsarebiddingup

thepricesofallkindsofriskierassets—fromequi-

tiestoemerging-market bonds—in search of bet-

ter returns. “It’s a huge question and dilemma for

savers,” says Andrew Bosomworth, head of port-

folio management in Germany for Pimco.

On the flip side, most banks in Europe haven’t

been able to pass negative rates onto their depos-

itors, squeezing interest margins ⑦. Advocates of

negative rates argue that they nonetheless have

helped boost overall bank earnings by underpin-

ning economic growth. But major European lend-

ers say further rate declines will cut into their

profitability. Deutsche Bank’s finance chief James

von Moltke told Bloomberg Television on July 24

that lower rates pose “a significant risk to us.”

The U.S. has never had negative rates on con-

ventional Treasuries, but it’s come close. Two-

year yields touched 0.14% in 2011 and stayed very

low until the Federal Reserve started hiking rates

at the end of 2015. Now, amid worries about the

economy, the Fed is expected to go back to cut-

ting rates this month. With 10-year Treasuries pay-

ing about 2%, negative seems a long way off—the

price of the bond would have to rise about 20%.

But the minus sign has become so commonplace

in so much of the world, nothing seems impos-

sible. Says Scott Thiel, chief fixed-income strate-

gist at BlackRock Inc.: “There’s no chapter in your

bond math book on this.” � John Ainger, with Phil

Kuntz and John Authers

InJuly,investorspaid

€102.64 for a German

bond with a face value

of €100.

Factoring in the price

paid, the smaller amount

received back, and

the (lack of) interest

payments, the yield is

-0.26%

If they hold it to maturity,

in 10 years, they will get

€100 back

The bond pays investors

annual interest of

0%

LENDING. BLENDED DOMESTIC AND OVERSEAS LOAN SPREAD AS REPORTED BY THE BIGGEST FOUR JAPANESE BANKS, WEIGHTED BY THEIR SHARE IN TOTAL LENDING.*AVERAGENETINTERESTMARGINFORALLU.S.BANKS.SPREADBETWEENLENDINGANDBORROWINGRATESINEUROPEWEIGHTEDBYBANKS’SHAREINTOTAL

DATA: BUNDESREPUBLIK DEUTSCHLAND FINANZAGENTUR, WORLD BANK, EUROPEAN CENTRAL BANK, FEDERAL RESERVE, COMPANY FILINGS, BLOOMBERG

1988 2018

70%

64

58

④Keyinterestrates

ECB SwissNationalBank

DanmarksNationalbank BankofJapan

⑥Working-age(15-64)peopleasa

shareofthetotalpopulation

World EuropeanUnion Japan

1/2007 6/2019

6%

3

0

-3

⑦Bankinterest

margins*

U.S. Europe

Japan

2014 Q1 ’19

3.4%

1.5%

0.8%

3.0%

1.8%

1.0%

1/2010 6/2019

3%

2

1

⑤ Expected inflation

rate for the euro area,

measured by swaps for

the second half of the

next decade

③ How to get a

negative yield, using

German bonds as an

example