January 2015 has seen the eurozone bond market rally to historical lows across all maturities. Abundant global liquidity, mainly from Asia (e.g. the effects of quantitative easing (QE) in Japan), is seeking safe and liquid investments. This, along with the ECB’s new “Expanded Asset Purchase Programme” (EAPP) announced by Mario Draghi on 22 January has fuelled the rally in bond markets.
The consequences of the rally vary depending on the maturity of the bond in question. Bonds with a maturity of less than 10 years appear protected by the ECB’s accomodative monetary policy and EAPP – policies that should last many years now that quantitative easing in the eurozone encompasses government debt.
It is reckoned that over half of all sovereign debt now yields less than 1%. Between them Switzerland, Japan and the eurozone have a US dollar equivalent of 7.3 trn. negative-yielding government debt. In the eurozone the amount of negative-yielding government debt has risen from EUR 500 million (last October) to over EUR 1.5 trn. at the end of January. To put that number in perspective, it represents 25% of the total outstanding eurozone government debt. Or, in other terms, it is equivalent, to roughly the entire European investment-grade bond market. Or four times the size of the European high yield bond market.
Negative yields on this scale in eurozone government bonds will inevitably trigger a rally in eurozone credit markets as investors search for positive yields (the search for yield enters new territory).
Prior to the announcement of the EAPP, demand for short dated maturities was already strong, either as an alternative to money market investments (offering only a negative yield) or for regulatory reasons – banks will need to hold these securities as part of their Liquidity Coverage Ratio (LCR).
Yields of bonds with maturities longer than 10 years fell in the second half of 2014 in the wake of falling commodity prices. The decline in interest rates is such that the market now anticipates German 10-year rates staying below 1% as far as the eye can see. From the perspective of a bond investor this seems very optimistic but is it perhaps too pessimistic from an economic point of view? Germany’s economy grew by 1.5 % in 2014. If we add in the effect of the fall in rates generated by the EAPP and the fall in the price of raw materials, plus the recapitalisation of banks we have, à priori, all the elements for companies and households to gain in confidence and for growth to pick up.