By: Phil Kernen
Global interest rates have been historically low for over a decade, from the great financial crisis to the arrival of COVID to today. Inflation is changing the future for interest rates in the U.S., and accommodative monetary policy will soon be a thing of the past. Another notable reflection of its passing is about to occur.
Following the 2008-09 financial crisis, central banks said rates would be low for a long time. After several years of anemic economic growth, in 2014, the European Central Bank initiated a policy to move rates below zero, followed by the Bank of Japan in 2016. As interest rates went negative, many government bonds and highly rated corporate bond yields drifted below zero. Essentially investors paid bond issuers to borrow. Counterintuitively, many investors continued buying negative-yielding bonds for relative safety, liquidity, and cross-currency trading reasons.
In the U.S., the Federal Reserve repeatedly denied that a negative rates policy was under consideration, despite increased expectations during COVID. As a result, nearly all negative-yielding debt over the last decade traded outside the U.S.
In 2010, Bloomberg created the Global Negative Yielding Debt Index to track negative-yielding bonds and monitor the volume and returns of the group. We can see in the chart below that the volume of government and corporate bonds selling for negative yields was immaterial at first. Once negative rates became central bank policy in 2014, and beyond, the volume quickly grew.
Negative yield bond volume declined from 2016 to 2018 alongside slowly rising interest rates worldwide, but negative yield volume grew again before and after the global spread of COVID-19. By 2020, nearly $18 trillion in government and corporate bonds worldwide were traded at negative yields.
To our knowledge, the Global Negative Yielding Debt Index is not investable through an exchange-traded or mutual fund. Still, the index was a valuable tool to track the impact of these drastic and ultimately ineffective monetary policies. Volumes bounced around during 2021, but the decline since last November is the real story.
Inflation took root in 2021 following the pandemic’s arrival, and Congress designed the resulting fiscal policy to keep consumers flush with cash as government leaders shut economies down. The support worked too well, increasing demand for goods and services beyond our economic capacity. By December, the Federal Reserve acknowledged inflation pressures, accelerated the winding down of its bond purchase programs’, and planned to start raising rates in early 2022. Meanwhile, annual consumer price inflation for January 2022 reached 7.5%.
The European Central Bank entered 2022 with no plans to raise interest rates, but with European inflation climbing quickly too, that outlook is changing. In Japan, inflation is still weak, but yields may have little choice but to go along with increases elsewhere if only to stay competitive. Under the present trend, the volume of negative yielding bonds could be zero by April.
The disappearance of negative-yielding bonds reflects rising rates everywhere and is due to growing inflation pressures. Moving to higher rates to fight inflation will require adjustments, but the disappearance of negative-yielding bonds is good news. Interest rates are moving towards normalcy.