Analysis: End of an era in sight as eurozone borrowing costs rise above 0%
- End in sight now for the period of negative rates
- Less than 30% of eurozone bonds have yields below zero
- The trend requires a new mindset
- Banks, passive investors to take advantage of it
LONDON, March 31 (Reuters) – When eurozone interest rates turned negative in 2014, fixed-income specialist Michael Hampden-Turner recalls having to explain to bewildered bond investors how they could be charged for lend money to governments.
As central banks sought to help economies through a succession of crises by making it costly to hoard liquidity rather than use it, investors quickly found themselves paying many countries – and even some companies – to take their silver.
Savers have complained that the end of the practice of charging borrowers interest is depriving them of wealth, but by the end of 2020, 75% of euro zone sovereign debt on Tradeweb’s platform – about 6.7 trillion euros ($7.45 trillion) – were showing negative returns.
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Almost a decade later, Hampden-Turner, previously at Citi and now director of fixed income at FTSE Russell, sees borrowing costs rising above 0%. Now his younger colleagues have to get an idea of the positive returns.
“It used to be just about acquainting people with this, and now we have a whole generation of traders who have never experienced anything but negative returns,” Hampden-Turner said. “All of a sudden, it changes.”
More attractive yields could bring investors back to the region and boost the euro, while easing strains on banks and pension funds. Among the likely losers are riskier emerging and corporate bonds that have been bought in a hunt for yield.
Money markets see the ECB exit negative rates by the end of the year as it tightens policy to combat soaring inflation.
Less than a third of eurozone debt on Tradeweb’s platform now bears a negative yield, while Deutsche Bank estimates the global pool has shrunk to less than $3 trillion for the first time since December 2015, against a peak of more than 18 trillion dollars in 2020.
Yields on German 10-year bonds rose above 0% in January for the first time since 2019 and stand at 0.6%. Two-year yields turned positive for the first time since 2014 this week .
Switzerland and Japan also cut rates below zero from 2015 as part of an experimental – and arguably failed – effort to revive inflation and growth.
Blamed for a huge increase in debt and inflating housing and stock market bubbles, negative rates have also been bad news for pension funds and insurers, who use current bond yields to price future liabilities.
Because they can’t make money holding ‘safe’ government bonds, they’ve been forced to take on more risk: a 2019 IMF paper showed big pension schemes had doubled benefits to illiquid alternative assets since 2007.
German insurers whose investment products guarantee income in old age have been particularly under pressure, with regulators requiring them to build up additional reserves since 2011.
For banks, negative rates have hurt profitability by eroding their net interest margins. Eurozone bank stocks have fallen around 40% since 2014 (.SX7E) and Japanese banks have fallen 10% since rates there fell below 0% in 2016 (.IBNKS.T).
“If…interest rates are like a guide to the pricing power of banks, interest rates in Europe have been at their lowest for 5,000 years. So the pricing power of banks has been at lowest in 5,000 years,” said Morgan Stanley, head of European equities. strategist Graham Secker.
CHANGE IN THE AIR
As short-term bond yields turned positive this week, eurozone bank stocks gained nearly 4%.
Each ECB rate hike could add 10% to lenders’ earnings per share, Secker estimates – and 20% in Southern Europe.
A return to positive yields could also bring capital back from higher yielding assets.
Viktor Hjort, global head of credit strategy at BNP Paribas, estimates that insurance companies held 30% of European corporate bonds in 2016 but only 22% now, squeezed out by the ECB.
A February BofA survey predicted that these long-term investors would become Europe’s largest marginal buyers of credit.
“If you’re an insurance fund, the investment opportunities for you have just widened significantly,” said Helene Jolly, head of EMEA’s investment grade corporate debt syndicate at Deutsche Bank.
“Before that, it was harder for you to hit goals. You might have to go a little longer than you wanted, or have a slightly lower credit score.”
Investors are already returning to higher quality debt.
French and Belgian 30-year government bonds sparked strong investor demand after yields topped 1% in January, debt officials noted.
David Gillard, head of insurance and regulatory strategies at Allianz Global Investors, said the rise in yields “offers insurers that are underweight rates and spreads a good valuation point to increase credit market exposures.” .
Covered bonds, the safest bank debt and A-rated corporate debt are among the assets that are attracting insurers, he said.
Such “risk reduction” of the portfolio can hurt assets that have enjoyed negative returns.
Already “at the margin, (insurance companies) wanted to reduce some of that risk…particularly from emerging markets, that was a concern,” said Gerard Fitzpatrick, head of portfolio management. bondholders at Russell. Investments.
But with Eurozone rates set to peak at just over 1% and no signs of a rise in Japan and Switzerland, the unwinding could take years, especially as inflation-adjusted yields remain negative. , unlike emerging economies.
“We’re not going to throw a party and break out the champagne because the returns are above zero,” said Ludovic Colin, senior portfolio manager at Swiss asset manager Vontobel.
“What we need to understand is where they are going, not where they are now.”
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Reporting by Dhara Ranasinghe and Yoruk Bahceli; Additional reporting by Danilo Masoni in MILAN, Tom Sims in FRANKFURT, Kevin Buckland in TOKYO and Sujata Rao in LONDON; Editing by Sujata Rao and Catherine Evans
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