The quest for positive yields
What should we call High Yield (HY) bonds that have negative yields?
For the first time, negative yields have crept into corporate junk bond markets. Selected HY bonds are now starting to offer sub-zero yields in a space where investors traditionally hunt for higher yields in riskier companies.
In Europe, about 2% of the HY market offer negative yields, including bonds issued by tech-equipment company Nokia Corporation, telecom giant Altice France SA, and aluminum products manufacturer Constellium NV. The only way to make money from negative yielding bonds would be to hope that rates/yields go even more negative.
The amount of negative-yielding debt in the global Investment Grade (IG) space remains elevated at around USD13t, which is 23% of the global IG universe. (Figure 1).
These negative-yielding bonds also seemed to have compressed US Treasury (UST) term premium, distorting signals sent by the US yield curve (Figure 2) which, if true, could have reduced the reliability of the US yield curve as a recession predictor. The sum of negative-yielding bonds (both IG and HY) looks set to increase further, at least in the short term, as markets price in further monetary easing from G-3 central banks. That is true especially in Europe, where incoming European Central Bank (ECB) President Christine Lagarde – due to start 1 November – is expected to continue the central bank’s dovish policy.
Some interesting data to consider:
- About half of sovereign debt from Japan and Europe, amounting to around USD5t in each market, are now negative yielding.
- German government bonds with maturities of 15 years or shorter are all negative yielding.
- Bonds of emerging Europe economies like Poland and Hungary are also starting to trade at sub-zero yields.
- Austria’s century bond, which matures in 2217, now yields only 1.2%. This bond’s recent EUR1b extension tranche was five times oversubscribed.
- US is the only G-3 country where none of its USD16t debt see negative yields.
- HY bonds, notably EUR-denominated ones, have started to offer sub-zero yields since early-July.
Figure 1: Negative-yielding bonds’ proportion stays elevated, at 22%
Source: Bloomberg, DBS
Figure 2: Negative-yielding bonds seem to have distorted the US term premium
Source: Bloomberg, DBS
What does this mean?
With G-3 central banks looking to cut benchmark rates, the negative-yielding bond phenomenon looks set to stay. In the US, Fed futures are pricing in two rate cuts by the end of this year, and an additional two cuts in 2020. In Europe, the ECB’s dovish stance is expected to continue – at June’s meeting, current ECB President Mario Draghi suggested further rate cuts and new bond purchases should growth and inflation slow. In Japan, the Bank of Japan (BOJ) may be forced to consider more stimulus, especially if Federal Reserve’s rate cuts materialise thus strengthening JPY.
While the negative-yielding bond malaise has spread from IG to HY bonds, the consolation here is that the USD and SGD bond curves are still positive. The sectors we have been advocating since the start of the year – USD BBB/BB-rated corporate bonds, Singapore Real Estate Investment Trusts (SREITs), and the “big five” Chinese banks – have done relatively well on the back of the relentless hunt for yield. We also like them for their steady cash flows.
SREITs outperformed in the first half of the year, with yields and yield spreads compressing to 5.4% and 3.5%, respectively. These levels are no longer cheap. Yet if we consider the backdrop of negative-yielding bonds worldwide, the 5.4% yield offered by SREITs is attractive, being the highest among global REITs. In fact, we have seen increased interest in the SREITs sector from Japanese institutional investors who are seeking higher yields outside of their home market.
What should you do?
We advocate investors to stay on the quest for positive yields in USD BBB/BB-rated corporate bonds , SREITs, and the “big-five” Chinese banks.
Further, equities remain the only game in town; given the backdrop of growing negative-yielding bonds, dividend-yielding equities are also good alternatives to bonds. In view of the already negative benchmark government bond rates in Japan and Europe and further easing expected by all G-3 central banks, the phenomenon of negative-yielding bonds is set to stay, at least in the short term.
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