Chart of the week: Going sovereign
Source: Refinitiv Datastream (as of 24 June 2019)
Central banks are concerned with the health of the global economy and, as a result, may be moving toward easing policies. Between the US-China trade war, geopolitical tension in the Middle East, and persistently low inflation, there are a number of reasons for central banks to cut interest rates.
The US Federal Reserve (Fed), which undertook a rate-hiking cycle from 2015 through 2018, has pivoted toward a more dovish stance in 2019. At its June meeting, the Fed announced it would not raise rates further in 2019. Markets have already priced in two 25 basis point cuts before the end of the year.
Meanwhile, the European Central Bank (ECB) indicated that it too will pause interest-rate hikes and potentially reinstate quantitative easing (QE). This news comes only six months after the ECB ended the QE program it put in place in the aftermath of the global financial crisis.
Inflation expectations across most economies have plummeted. The Fed dialled back its inflation projections for 2019, revising down to 1.5% from its 1.8% forecast in March. The euro five-year forward, five-year inflation swap rate, a gauge of 10-year expectations, is pricing in an average 1.3% annually after bouncing off an all-time low. This leaves investors facing a backdrop of falling inflation expectations and low interest rates.
This is a good combination for both risk and risk-free asset markets. The S&P 500 Index has reached a new record high, US 10-year bond yields are back beneath 2%, after having been above 3% as recently as December.
The result has been a bond market rally. Many concerned global investors have moved toward safer assets, such as government bonds. So many investors, in fact, that the total amount of sovereign debt with negative yields has swelled to $12.5 trillion. Negative yields are increasingly becoming the new normal. By holding these bonds to maturity, investors will likely realise losses.
Core Europe, Switzerland, Nordic states and Japan make up most of the issuance. Even out to 40-year maturities, the Swiss curve yield is negative. Peripheral Europe, including Ireland, Spain, Portugal and even Italy, have negative-yielding bonds. Though Europe makes up a sizeable portion of global negative-yielding sovereign debt, Japan dominates by far with an issuance in excess of $7.5 trillion.
The Fed is set to cut rates, the ECB will go further negative and restart QE if necessary, and the Bank of Japan has promised more action. This may raise the question: aside from the Fed, how much is left in central banks’ armouries? We may not know the answer, but one thing is certain – we remain in a world of low (or negative!) numbers
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