How Long Can Central Banks Push Bonds to Absurdity?

Central banks around the world have fallen all over each other lowering their benchmark interest rates. On Tuesday, the Reserve Bank of Australia was the latest, cutting its cash rate to an all-time low of 2.25%. It didn’t mince words: “A lower exchange rate is likely to be needed to achieve balanced growth in the economy.” A rare admission of escalating the currency war. The Aussie dollar immediately swooned.

Two weeks ago, the Bank of Canada suddenly cut its overnight interest rate by 25 basis points. Other central banks have chimed in. Japan’s rate has been at zero for years. “Negative deposit rates” have infected a number of central banks, including the ECB.

In this environment, the Fed is talking about raising rates from zero to next to zero, but the markets are not following its hints and are trying to force it to back off.

Ten-year government bond yields in Japan and Germany dropped closer to zero, before bouncing off in a sharp rally to 0.39% and 0.31% respectively. This is called the “Japanification of Germany.”

Back in August 2013, when 10-year JGBs still yielded around 0.8%, I wrote, Why I’m Deeply Worried About Japan – And Why Betting On The Collapse Of JGBs Is A Horrible Idea, which has become a leitmotif. Japan’s fiscal situation has deteriorated since, but JGBs have risen and yields have dropped, with shorter maturities sporting “negative” yields. JGB shorts have been kneecapped. Inflation is 2.4% as measured by the all-items index, and 3.1% for goods. Financial repression has become the rule.

The ECB is barreling down a parallel path, but at least in the Eurozone workers and consumers currently enjoy true price stability, though that is total anathema to central banks, most governments, the media, and corporations who have become dependent on using inflation for their own benefit. Since October 20, the ECB has bought €40.3 billion in “covered bonds,” which are backed by assets and guaranteed by the issuer. By September, in anticipation, covered-bond yields became negative.

It also bought €2.3 billion in asset-backed securities to push their yields down. Throughout, those who own these types of securities are watching their values balloon into the stratosphere.

So the ECB decided in January to buy €60 billion in government bonds a month. This decision had been expected for a long time. And government bond yields have turned negative in an increasing number of member states, for longer and longer maturities.

European high-grade corporate bonds have followed in lockstep. Nestle SA, the Swiss food conglomerate, might be the first company whose debt trades with a negative yield. Its notes, rated Aa2 and not even triple-A, due October 2016 were quoted at a yield of 0.05%, just a hair from zero, Bloomberg reported. Breaking below zero would be a logical step.

Notes that drug maker Roche Holding issued in 2009 and that mature in March 2016 traded at a yield of 0.09%. Whoever bought these notes in 2009 and sold them today made a chunk of money, thanks to the ECB. It’s “market-driven,” said Roche’s media relations head, Nicolas Dunant. The bond has become “increasingly attractive for investors in the current low-rate environment.”

The average yield of high-grade corporate euro bonds dropped to a record low of 0.987%. Less than 1%! At the end of 2013, the average yield was still 2.1%. They may be headed where covered bonds already are: Deutsche Bank’s home-loan-backed covered notes maturing in 2018 yielded a negative 0.03%. Mortgage rates in Denmark are already negative so that people are paid to take out mortgages; it’s fighting back in the currency war that the Eurozone has embarked on.

Investors are going to pay the price. But where else are they going to park their money? They’re going to pay for parking it at the bank, based on the negative deposit rates the ECB has inflicted on its banks that in turn have started to pass them on to their large depositors. The only hope for investors is that bonds will rise even further, with yields dropping ever deeper into the negative. This way, they might make money off the price, if they sell at the right time.

But how much longer can this absurdity go on?

“The basic logic is for yields to fall, but we must brace for widening volatility,” cautioned Kazuhiko Sano, the chief bond strategist at Tokai Tokyo Securities, at a January 27 event in Tokyo, according to Bloomberg. He’d predicted that 10-year JGB yields would drop to 0.5% by 2013 and to 0.25% by March this year. Ahead of his schedule, it plunged to 0.195% on January 20.

So now he sees the yield drop to 0.1% by March 2016, a good day away from going negative. The median forecast of nine economists that Bloomberg surveyed expected the yield to rise to 0.5%.

The Bank of Japan, by printing ¥12 trillion ($102 billion) a month to buy mostly JGBs, is monetizing over 90% of the new debt the government is issuing. It has become the relentless bid, and the JGB market has withered. The buying binge will drive down yields further, Sano said, but price swings could be wild: “Liquidity has shrunk so much that any selling could cause yields to spike.”

As I’m writing this, the 10-year yield has jumped to 0.39% – doubling in less than two weeks! Sano wasn’t kidding about wild volatility.

The potential for a slowdown in the EU could trigger a global recession and persuade the Fed to delay its first interest rate hike into the nebulous future. This would further pressure government bond yields, Sano said; “It’s hard to think Japan will be an exception.”

And 10-year Treasury yields could skid to 1%, despite the Fed’s rate-hike cacophony, DoubleLine Capital’s Jeffrey Gundlach has been saying since December. He’d nailed the plunge in Treasury yields last year, while most gurus thought they’d rise.

These ludicrously low yields, a phenomenon the world has never seen before, cannot be ascribed to the fear of a global recession. Global recessions are nothing new. But these yields are.

What these yields do show is that the markets for government debt, and increasingly for high-grade corporate debt, are completely controlled by central banks. There is no more price discovery. Risk has disappeared as a factor. The potential of inflation no longer matters. Any doubts are immediately pooh-poohed.

By throwing free money around that has to go somewhere,and by making leverage essentially free, central banks have catapulted asset prices into absurdity. They have created a mechanism by which governments and corporations can load up on debt without paying the otherwise normal costs of capital, and sometimes at an outright profit, while at the same time depriving those whose money this is – regular investors, pension funds, savers, and others – of a return. Confiscation comes to mind.

But there are costs. It saddles these governments and corporations with a future problem: debt doesn’t just go away. It has to be rolled over (or be paid off, a novel concept in these circles). But many of these entities cannot afford higher rates on their pile of debt. Then what? Force rates to or below zero forever?

It’s going to be tough. This is an economy where risks can no longer be priced, where the cost of capital is nil for some, and where price discovery isn’t handled by market participants but by central banks. Throw enough money at anything, and you’ll kill it.

So hedge-fund guru Paul Singer explains why they’re all buying these assets: a “wish not to be run over.” Read…  Immensely Concentrated Positions in “Fantastically” Overpriced Markets with “Unlimited Tolerance for Risk”

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  14 comments for “How Long Can Central Banks Push Bonds to Absurdity?

  1. Dan Romig says:

    “… a mechanism by which governments and corporations can load up on debt without real costs involved, …”

    Well stated Wolf, but as I commented yesterday to ‘Immensely Concentrated Positions in “Fantastically” Overpriced Markets with “Unlimited Tolerance for Risk”‘, the U. S. government is already loaded up on debt.

    The Fed and the world’s central banks have indeed dropped rates to zero, more or less, and what is the result? First, savers see nothing returned on their deposits and some actually PAY a bank to hold their cash (mattress anyone?). Do central bankers really expect this scenario to play out long term? And secondly, banks have access to free capital, which they hoard or lend out at a tidy profit.

    This nation’s infrastructure is in need of investment by Uncle Sam and the states. While governments can load up on debt for the cheap as we can now, it should be used to put skilled labor back on the job to fix roads, bridges and railways. That’s the only way we’ll grow our economy and address the $18 trillion monkey on our backs.

  2. It appears the central bankers of the world have united to fight the deflation dragon. We’ve seen rate cut after rate cut, printing presses on full blast, and unelected soothsayers spouting more gibberish than a schizophrenic homeless octogenarian. Make no mistake, the central bankers are trying everything they can to create artificial inflation. Unfortunately it seems not one of these central bankers has cared to pick up a history text. For if they did, they’d see that any advantage gained from a falling currency is only temporary.

    No one wants to crash first. Instead they are trashing their currencies to remain competitive. But someone does always crash. Will that be Greece? The country has been in central banker jail for some time now and without additional assistance it could be the first to go and soon. The media has tried very hard to tone down Varoufakis’ rhetoric but the message remains the same “Greece cannot and will not repay all its debt.” There’s a showdown approaching. Who will blink first? SYRIZA has already stated that it is not willing to leave the EU which perhaps is its biggest bargaining chip. If it wants to win the negotiations they will have to be prepared to lose it all. For anyone hoping for an ending to the madness the near term hopes must lie with Greece.


    • GroundedMadness says:

      The “canary” may be Switzerland. Independent, developed economy whose Central Bank, maybe more than any other, has evolved into a hedge fund in pursuing policy to harness the markets.

      Is the SNB so good at speculation that it escapes from its balance sheet risks? It may portend what the US Federal Reserve may face as worldwide liquidity keeps fleeing the peripheral financial markets. In the end, every market is the periphery to the US.

  3. Paulo says:

    I admit to being a (God forbid) saver. My wife and I paid off our home years ago by ‘foolishly’ saving a percentage of our net, thereby allowing us to pay off our mortgage by age 50. Actually, it allowed me to pay off first house (a shack) at age 30, 2nd (a modest rancher) by age 40, and rural homestead with property at 50. No mortgage allowed me to retire at 57, wife at 55. We still save a % of our modest income, and manage to live like kings. In fact, I just bought a new motorcycle for cash. (What a novel idea). My kids are educated and on their own living their own lives, and also hopefully saving a percentage of their own incomes. (They seem to do that, but being in their thirties their life is their own business). Dad did supply their house down-payments, though…out of (you guessed it!) savings.

    We certainly make nothing with our accounts, GICs, and the like, but I don’t have to worry about losing it either. My friends are still chortling about their market investments and shake their heads at me. They are still working, and spending lots. The last downturn a friend had to carve up his property to recoup his losses. I expect we will soon be seeing this again, any day now.

    • CrazyCooter says:

      Having grown up modest and ended up in applied CompSci/Engineering, I have seen many people (smart and dumb) all along the way. I am personally biased toward the idea that “savers” have a gene that most people do not have. You can’t teach it for the most part, any more than you can teach a wide range of human propensities. Deep down, people either enjoy spending it or enjoy saving it.

      I have seen very smart people do very dumb things with money and very simple people very smart things with money.

      I hope to be 100% debt free in 12 months, give or take 6, and I will never, ever borrow again. I think there must be more like me, because that is what the CBs are doing battle with. People are eschewing debt, I think, as part of a long term cycle. Banks just want a free lunch, and people, even though they lack the “saving” gene, are wising up and buckling down for genuine hard times.

      I was an inflationista for years and years, but probably in the last year I really came around to the deflation camp.

      The CBs are fscked and it will be very hard to pitch a new fiat system in the collapse. Things are going to get dicey.

      I hope you live in a very low tax muni-county-state, because they will be squeezing blood from stones before this is over!



  4. MC says:

    I was recently weighing some investment options for 2015.
    There are two basic rules for the ordinary person who wants to invest to avoid having to eat dog food in his old age (though, as a dog owner, I’ve noticed “deflation” doesn’t apply to this particular item: 2014 was a bloodbath).
    First is to invest on something yielding official CPI figures plus around 3% (after taxes).
    Second is to buy low and sell high.

    The first item is now junk bond territory. The risks of losing one’s shirt are becoming unacceptable, especially in the commodity sector.
    The second item had a good ride, but the law of diminishing returns is biting with a vengeance. Everything is massively overpriced. And bonds are the worst culprits of all.

    Those interest rates floating around zero clearly say there isn’t much room to go up. Yes, they will go up a bit more, but bonds are reaching such insane valuations they are simply becoming too expensive for those without access to “free” money.
    Government bonds still have a market: QE. But how long before central banks will simply monetize debt with freshly printed money instead of buying bonds on the secondary market? How long before voters will throw the deflation myth in the face of those who invented it? However, until then the party continues, though at an increasingly sluggish pace.
    But corporate bonds… those valuations and yields depend on one thing and one thing only: finding a greater fool down the road ready to pay more for them.
    I am not speaking about fools lightly: with rapidly degrading fundamentals, those bond values and yields are completely unwarranted.

    Yet, if we are to believe the stock markets, this situation may soon become untenable.
    In the old days there was a saying: let them bleed, then buy. It means you didn’t buy stocks and bonds after they lost 1-2%. You bought after they dropped 7-8%. Remember: buy low, sell high.
    But right now stock markets immediately rebound after losing 2-3%. It’s all about buying the dip, no matter how insignificant, not buying low.
    Traders, very much like third and fourth tier keiretsu contractors, are working on rice paper thin margins. They make money on quantity. They cannot stop or even slow down.
    This means they are effectively trapped in their own game. They can only bid upwards, though with ever decreasing margins. They have to close their eyes to companies such Caterpillar and Amazon bleeding red ink all over the place. They have to ignore the fact once glorious companies such as IBM have become zombies kept afloat by financial engineering, not quality and innovation.

    To be completely honest, I have never seen such a risky game being played before in my life. I thought the Zaitech system was the biggest monument to senseless greed and boundless optimism I had seen in my life.
    Looks like I was completely wrong.

  5. SteveK9 says:

    To avoid or end a recession you don’t lower interest rates, perform QE, etc. The government spends money and puts people to work. For God’s sake Keynes taught us that 80 years ago … do we have to keep doing the same stupid things over and over?

    I realize in today’s world you will constantly be told to read this or that tract by some crackpot, so I expect this to be ignored, but if you want to take a chance …

    read Warren Mosler’s ‘The 7 Deadly Innocent Frauds of Economic Policy’. Short, and clear.

    Various essays here by an Australian Academic (if that puts you off stick with Mosler).

  6. Petunia says:

    All that financial repression has consequences, political instability. You are seeing it in Greece and Europe and it will travel here as well. The average voter sees all this financial engineering as a Wall St game to scam them out of even more money and property. Two thirds didn’t vote in the last election because they don’t feel invested in the system. It is like a divorce, you break up in your head a long time before you actually leave. The 2016 circus should be interesting.

  7. Richard Hill says:

    Why dont any commentators link national debt problems to demographics? Why would anyone lend money long term to a nation, eg Japan, Germany that wont exist in 2 or 3 generations?

    • Petunia says:

      Countries like corporations are assumed to be going concerns in perpetuity. The people in Japan, Russia, and China will always be there regardless of the kind of govt they have. If and when a change occurs the winners decide who pays and who doesn’t.

    • Wolf Richter says:


      Petunia is right. Don’t worry. Both countries will be around for a long time. People there may just be a little less crowded than they’re today.

      Ever been on a commuter train or subway in Tokyo during rush hour? It’s actually not as bone-crushingly bad anymore as it was when I first tried in 1996 (mostly because they added a lot of new lines), but it’s still insufferable for most Westerners. So backing off the idea that every country has to pack more and more people into its cities is a good thing.

      The fiscal woes of Japan will be dealt with in other ways, like devaluing the yen (and therewith the debt). It will take place over many years; that’s the hope. If they lose control, it might happen suddenly, which would be messy. Either way, it will be painful.

      About 95% of the Japanese debt is owned by Japanese institutions (including the BOJ) and households. Unlike Greece, they have not used foreign money to fund their profligacy. And they’re not looking for foreigners to fund it. They’ve got the BOJ. It’s doing most of the funding now :-]

  8. The plunge in interest rates is evidence that interest rates — and central banks — have become irrelevant. All that remains is for central bankers to start working in the nude (well … maybe not).

    What determines the price of money in 2015 is its voluntary exchange for a valuable physical good — gasoline — millions of times a day at filling stations all over the world. Priced in fuel money has worth. Priced in future money (current cash + interest) = meh!

    Some money is worth more than others: what is underway is a three-tiered money regime: the US dollar is at the top, ‘Brand X’ failure currencies at the bottom with scrip (local-‘currencies’, cigarettes and liquor, ammunition and other barter goods). Dollar is king because it offers the best deal on petroleum. It becomes a proxy for petroleum in the place of what can be done with the petroleum (commerce). The dollar becomes a hard currency like the gold-backed dollar of 1932. This is called ‘dollar preference’.

    The outcome is the same: in 1932 most of the banks in the country were closed, dollars could not be had: they offered the best deal on legally required gold. The business of the world was reduced to trading paper go gain gold just like the business of the world in 2015 is trading paper to gain petroleum.

    We haven’t seen out-and-out dollar preference … yet. But we will, the process is just beginning, when it becomes entrenched there will be no way out of it but to ‘go off oil’ the way the US went off gold in 1933. Did I mention the US Treasury was nearly bankrupt in 1932? Japan’s treasury is bankrupt now …

    Watching the central banks writhe in agony is instructive: there is no way to escape the deflationary consequences of our ongoing energy waste. We stop wasting or else it will be stopped for us.

    • CrazyCooter says:

      As far as energy goes, on a half-human life span (40 years) oil production will be so precipitously lower than present levels it will boggle the mind in terms of repercussions.

      People widely fail to realize that not very long ago, highly educated and successful people had chamber pots and outhouses. Absent a steady stream of widely available, and affordable energy, that is where things will return.

      And y’all can tout all the green/renewable/etc you want, but it is a rounding error when compared to fossil fuels – and always will be. This strongly implies great belt tightening over the coming decades or a great many less consumers.

      People further have little to no understanding about the petro-chemical supply chains that give them pretty much anything associated with a modern lifestyle (hippie energy doesn’t touch this subject). The products on the market backed by petro-chemical stocks are all the new fancy things that showed up over the past 60 years as they replaced the prior wood/glass/metal versions.

      Nature will choose if we do not!



  9. Julian the Apostate says:

    The pendulum (my how quaint that sounds) is swinging toward chaos at the moment. It will swing back, eventually but at the cost of a lot of pain and suffering. Over 5000 years of written history the technology advances or retreats but the people are always the same. None of this will matter in a hundred years except to some dusty academic banging away on an old Smith Corona because no one knows how to repair the old tech. If he’s lucky he’ll gather a few gems from us that will be worth nothing to anyone else.

    “No matter what anyone else does or says, I must be emerald, and keep my color.” -Marcus Aurelius Antoninus

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