For Americans accustomed to paying 4 or 5 per cent mortgage rates, let alone the double-digit figures consumers endured in the early 1980s, the new loan from Denmark’s Jyske Bank might seem inconceivable.
The Danish lender last week started offering home buyers 10-year mortgages at an interest rate of -0.5 per cent. That means borrowers over a decade will pay back a little less than the amount borrowed, not including one-time fees.
This is the ultimate indicator that something is fundamentally wrong with the world economy
Adam Posen, president of the Peterson Institute for International Economics
This highly unusual condition may be good for Danish home buyers, but economists say it’s an alarming sign for the global economy. Several major governments and more than 1,000 big companies in Europe are now able to effectively borrow from global financial markets at a negative interest rate. For Jyske Bank, that means it can then turn around and lend money at a subzero interest rate, too.
The amount of this type of debt, issued as government or corporate bonds, has doubled since December and now totals US$15 trillion.
The sudden increase suggests that a fast-rising share of investors are so nervous about the future they’re willing to actually lose a little money by lending it to a borrower that is almost certain to pay it back, rather than risk betting on something that could go bust. In a healthy economy, investors would put their money to work in profit-making ventures such as factories or office buildings.
“It’s an absurdly odd world and it signals two things,” said investment banker Daniel Alpert, managing partner at Westwood Capital. “There’s an obvious, persistent and continuous glut of underutilized capital and there’s no place in the advanced world for that capital to be invested without excess risk.”
Economic growth is slowing around the world, in part driven by President Trump’s trade war. But there’s a growing debate over whether the global economy is only softening, or coming in for a hard landing.
While recent economic data suggests that manufacturing, in particular, is cooling, the interest rates paid by bonds, known as yields, usually only collapse during times of serious economic stress, such as the 2008 financial crisis or the Euro-crisis that hit Europe two years later.
Today, Japan, and seven major European governments, including Germany and France, are able to sell bonds with negative yields, as are corporate behemoths Nestle and Sanofi, whose size gives investors confidence they could withstand a downturn.
The United States hasn’t seen such upside-down bonds yet, though the yields on U.S. government debt have plunged. And in recent days, top analysts at two giant investment houses – Pacific Investment Management Co. and JPMorgan Chase – have predicted that U.S. Treasury bond yields could go to zero or lower if the U.S. tumbles into recession.
“This is the ultimate indicator that something is fundamentally wrong with the world economy,” said Adam Posen, president of the Peterson Institute for International Economics. “The escalation of the trade war is making it worse.”
Fallout from the president’s unpredictable trade offensive is driving up the danger of a recession
Indeed, the trade war is intensifying bond market fears of the first global recession in a decade. After Trump tweeted on August 1 that he was putting tariffs on an additional $300 billion in Chinese goods, more than $1.7 trillion of bonds slid into negative territory over the next week, according to data compiled by Bloomberg.
An investor who buys a bond is effectively loaning a company or government money. Bond buyers typically demand a rate of return, or yield, to compensate them for the use of their money and the risk that inflation will erode the value of the payments they receive over time.
Bond yields and prices move in opposite directions. So falling yields mean that more and more investors are piling into the bond market, driving up bond prices.
Outside the U.S., 43 per cent of bonds are trading at a negative interest rate up from 20 per cent late last year, according to Deutsche Bank Securities.
Negative yields on bonds first appeared in 2014 after the European Central Bank cut its main interest rate below zero and began buying bonds in a bid to goose the economy. The total value of bonds trading with below-zero yields has more than doubled since December. The promised return on Germany’s 30-year bond plunged below zero earlier this month for the first time ever.
The bond market’s ills demonstrate that the indirect effects of Trump’s trade war may be more costly to the global economy than the tariffs he has imposed or threatened on goods from China, Mexico, Canada, the European Union, Japan, India, Vietnam and Guatemala.
Fallout from the president’s unpredictable trade offensive is driving up the danger of a recession before the 2020 election, economists say,with a closely-watched Federal Reserve Bank of New York gauge putting the changes at almost one-in-three over the next 12 months.
“In the short term at least, most of the economic damage from the tariffs is likely to stem from the indirect effects on things like business confidence and investment rather than the direct effects on trade flows,” Neil Shearing, chief economist at Capital Economics, wrote in an August 8 research note. “These indirect effects are difficult to measure and can extend beyond the countries imposing tariffs on one another.”
Federal Reserve Chair Jerome H. Powell cited “trade policy uncertainty” last month in cutting the benchmark lending rate by one-quarter of a percentage point. Four more central banks – India, New Zealand, Thailand and the Philippines – followed suit last week. The European Central Bank is expected to join the rate-cutting and perhaps resume its asset-buying program before the end of the year.
“The escalation of trade tensions has been one of the factors driving a new global easing cycle by central banks,” Mohamed El-Erian, chief economic adviser for Munich-based Allianz wrote in an email. “It’s a race to the bottom for global interest rates, with no one really wishing to see their currency appreciate given the weakened growth outlook for the global economy.”
Those rate cuts are another factor driving demand for bonds and helping to push interest rates into negative territory.
The emergence of negative-yield bonds is a consequence of the ECB’s efforts to fight lingering economic weakness by slashing interest rates and buying US$3 trillion in bonds. Likewise, the Japanese central bank, the Bank of Japan, took action to push down rates in January 2016, which had similar effects.
This is a credit crunch. And a credit crunch is a known economy-killer
Carl Weinberg of High-Frequency Economics
The spread of subzero bonds erodes profits for banks and may make it impossible for some insurance companies and pension funds to earn enough from their investments to meet their obligations to policyholders and retirees. Some insurers could fail while banks cut back on making loans, starving the economy of fuel needed for growth.
“This is a credit crunch. And a credit crunch is a known economy-killer,” said economist Carl Weinberg of High-Frequency Economics.
If these unusual financial conditions persist, the economic costs would likely mount. Offering credit at negative rates distorts incentives for investment, potentially fuelling asset bubbles that could pop with devastating consequences.
The Bank for International Settlements in Basel, Switzerland, an organization of central banks, has linked ultra-low interest rates to the emergence of “zombie” firms. These are unproductive companies that would fail if debt costs were at normal levels. Instead, they linger, hogging investment and workers that could be put to more productive uses, according to BIS.
“You can survive, quote-unquote, or can live with negative yields for quite some time. Indefinitely? It would be very odd to think about that being possible. There would be distortions in the economy,” said economist Claudio Borio, head of the monetary and economic department at BIS. “You will have resources in the wrong sectors, in the wrong firms and therefore productivity and growth will suffer. On top of that, you’re likely to have quite a lot of debt out there, which will make it harder for policymakers to raise rates without creating some tensions and problems.”
Indeed, the prevalence of negative yields is complicating central banks’ management of the economy. In Europe, ECB President Mario Draghi hinted at more monetary policy easing ahead, which would likely deepen the bond market’s negative turn.
Europe’s central bank chief said last month that euro zone rates will remain at or below current levels through the first half of next year and he raised the possibility of restarting the program of quantitative easing or bond-buying that he shuttered only last year.
“If interest rates keep going down, the banks will be under pressure. If they go up, governments will be under pressure,” said economist Ashoka Mody, a former International Monetary Fund official. “They’re caught in a bit of a pincer.”
The Fed’s main lending rate, meanwhile, is just 2 per cent to 2.25 per cent, well below historic norms. If Powell keeps cutting, as investors expect, the Fed will have little ammunition left to fight the next recession.
For now, the 10-year U.S. Treasury remains in positive territory, though well below the long-term average yield of 6.1 percent since 1961. The yield has fallen to 1.7 per cent from 2.8 per cent in January, an indication that bond investors do not share the president’s optimism about the economy.
“Our country is doing fantastically well,” Trump said August 9. “You look at Europe; they’ve got problems. In fact, the biggest problem we have is the fact that a lot of other – continents, frankly – but a lot of other countries are not doing well.”
Some analysts say the U.S. bond market will never go negative. But others see a much more perilous scenario:
The U.S.-China trade war festers, chilling global trade and slowing growth worldwide. Economic weakness infects the U.S., prompting the Fed to slash rates to zero and restart its own program of asset purchases.
In that environment, the nearly US$16 trillion U.S. Treasury market could get drawn into the vortex of negative rates, triggering a dangerous financial malady.
“It seems very fragile at the moment,” said Torsten Slok, chief economist at Deutsche Bank Securities. “We’re walking on a tightrope.”
