The pile of negative yield bonds in global markets is shrinking fast, triggering debate if this means the economic outlook is turning positive.
While signs of an economic recovery are yet to be confirmed, one thing is for sure: such a decline rescues the global economy from a world where savings are discouraged and borrowers do not pay for credit risk undertaken by lenders. (The trend also benefits China – more on that below.)
Across the world, the volume of negative-yield bonds including corporate debt has plummeted to around $11.41 trillion from a peak $17.04 trillion struck on August 29, according to Bloomberg data.
“The recent rebound in global bond yields is a sign that the risks of a global recession have diminished. Indeed, we now estimate that the probability of a US recession occurring over the next twelve months has fallen to around 10% from a recent peak of 20%,” said Marcel Thieliant, senior economist at Capital Economics.
Still, 65% of those polled in the CNBC-SurveyMonkey survey released this week said they believed the U.S. economy was likely to begin retracting within 12 months.
Speculation about a recession in the world’s biggest economy has abounded ever since parts of the US Treasury yield curve began inverting. A normal yield curve indicates higher yields for longer bond maturities but that situation is reversed in an inversion when the shorter-dated bonds fetch higher yields compared with the longer-dated bonds. That happens because investors are nervous about the economy in the near term and demand higher premiums. In such a situation, bond markets perceive the near-term as riskier than the distant future.
Negative interest rates, on the other hand, are an unconventional monetary policy tool that central banks pursue sometimes. The European Central Bank cut its interest rates for deposits by 10 basis points to minus 0.5% in September and the Bank of Japan, which adopted negative rates in January 2016, charges 0.1% interest on a portion of excess reserves that financial institutions park with the BOJ.
Negative interest rates penalize holders of cash for not spending – and for those who are debt-free this is not good news.
“Borrowers should pay additional compensation for the credit risk undertaken by investors,” said Warut Promboon, Managing Partner at independent research firm Bondcritic. “Negative yields don’t encourage consumers to save, and without savings you can’t have investments. Savings are the backbone of an economy.”
While the pile of negative yield bonds has been slashed considerably in the past two months, it will not disappear completely. Negative yield bond volumes will wax and wane as doubts remain about global economic conditions and whether there will be a return to health any time soon.
And that is good news for at least one market that is also considered one of the last frontiers of global fixed income – China’s $13 trillion domestic bond market, which has no negative yield bonds and where regulators are keen to see foreign ownership rise from the current 3%.
Chinese government bonds yield twice as much as US Treasuries, and recent efforts to attract foreign investors may have received an additional push from the global yield environment. The ground conditions are also fast improving: Moody’s Investors Service observed that the turnover ratio in Chinese government bonds had doubled to around 12% and foreign ownership had more than doubled in the past two years.