Bonds – German bunds turn negative

The rally in bond prices reached fresh highs this week, as the yield on the benchmark 10-yr German bund turned negative for the first time. It’s yet another sign that the bubbling bond market is approaching a level that may not be sustainable.

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Zero Lower Bund

 

Bund yields went negative for the first time on June 14th, having fallen from around 0.6% at the start of the year thanks to aggressive buying by Europe’s central bank. The ECB is hoovering up just about every bit of top-rated government paper and is now so short of debt that it’s chasing corporate bonds too.

The ECB’s expanded quantitative easing programme means it can keep buying German paper until the yield matches the deposit rate – i.e., -0.4%, which indicates that there could be further for this rally to run, at least in the near-term.

Weak jobs numbers from the US at the start of June effectively scuppered the chance the Federal Reserve will raise short term interest rates at its meeting on June 15th, further fuelling the bond rally.

And it’s not just Bunds. Other safe havens are being eagerly sought, with yields on UK gilts and Japanese government bonds at record lows. US Treasuries are at their highest in over three years, with yields retreating to the their lowest since December 2012.

Meanwhile, collapsing bond yields is producing a chilling effect on banks – Deutsche Bank’s share price has fallen in tandem with bund yields. The Stoxx Europe 600 Banks index is trading down 26% year-to-date as the effect of low yields and negative interest rates is felt keenly.

‘Supernova’

 

For many institutional investors, the bond market is not a pretty picture with around $10 trillion in government paper now negative - completely uncharted territory.

Janus Capital boss Bill Gross doesn’t think it can last. In a tweet, he said: “Global yields lowest in 500 years of recorded history. $10 trillion of neg. rate bonds. This is a supernova that will explode one day.”

Aggressive monetary easing by central banks has driven down yields in most developed economies. A push into negative rates is seen by some as the last throw of the dice for central banks seeking to reflate their economies, but it may have the opposite effect.

DoubleLine boss Jeffrey Gundlach told a Swiss paper that negative interest rates are “the stupidest idea I have ever experienced”, adding that the next major market event (and probably not a pleasant one) will be when central banks in Europe and Japan “give up and cancel the experiment”.

According to Peter Thiel, the billionaire investor and Facebook board member, the government bond market is in bubble territory. BlackRock chief Larry Fink has also called negative rates into question, saying that rather than sparking growth, the policy is hurting consumer spending.

The Bank for International Settlements and the International Monetary Fund have also warned about the potential risks around negative rates – the giant pile of negative-yielding government paper would seem to indicate that something is very wrong in the bond market.

Of course, all this could alter rapidly if the Fed decides to raise rates again soon. Futures trading points to barely a 4% chance of this happening in June, although the chance of a July rise is higher.

Added market volatility means increased opportunity but also more risk. To reflect this, ETX Capital may be increasing margin rates on certain markets.