This is just the beginning, a new trend that may well turn into the next craze. ECB President Mario Draghi, in his infinite wisdom, asked for it: he’d driven the ECB deposit rate deeper into the negative, to -0.2%, and has promised to buy €60 billion of assets a month, including Eurozone government debt, other debt, and even, as German politician Frank Schäffler had predicted so poignantly in July 2012, “old bicycles.”
The ECB would buy this debt from its favorite banks, driving up the price so high that the yield would drop to -0.2%, same as the deposit rate. These banks are going to make a killing on the deal. And yields of Eurozone government debt have been plunging, with the German 10-year yield now at 0.15% on its way to -0.2%.
The goal: Make investors pay for the privilege of funding all governments across the Eurozone, just like depositors are being made to pay for the privilege of lending their hard-earned money to shaky banks.
Insurance companies, but also other financial institutions, hold high-grade bonds to create predicable income streams into the future with which to pay the promises they made to holders of their life insurance policies and annuities – a big part of the private pension system. But as yields are turning negative, future income streams fizzle. It’s undermining an entire retirement system.
So the reckless chase for yield across the Eurozone is on. They close their eyes, hold their nose, and wade into more risk, driving down yields in the process. Already high-grade corporate bonds are experimenting with zero and negative yields. By March 10, as the ECB was kicking off its QE, average yields on investment-grade corporate bonds had dropped to 0.85%, though they have since ticked up to 0.92%. Not enough yield to fulfill the promises.
So they seek salvation in junk bonds. These risky creatures do well when endless new money is available to pay off old money. But that can turn on a dime. When it does, bondholders lose much of their investment and can end up with very little after a “restructuring,” for example under the protection of Chapter 11 of the bankruptcy code.
This is happening in the US energy sector right now. These things are called “junk” for a reason. In the past, investors took the risks because they were rewarded with high yields. But not anymore, not since global QE and interest rate repression ruined pricing of risk.
And so yields of euro-denominated junk bonds have plunged, with the average yield hitting 3.56% on February 27, though it has since ticked up to 3.92% on Thursday. By comparison, in the US, the average yield for equivalent dollar-denominated junk bonds, according to BofA Merrill Lynch high-yield index was 6.30%.
It doesn’t take a genius to figure out what’s next.
US junk-rated issuers see this difference. They know where the cheap money is being offered. They know where to find desperate investors driven to near or total insanity by central bank policies.
Laboratory products distributor, VWR Corp., out of Radnor, PA, just went public in October, raising $536 million. It’s part of the exit strategy of its PE-firm owners led by Madison Dearborn Partners. Now it needs more money. So on Thursday, according to Bloomberg, it sold €503.8 million in junk bonds in Europe.
IMS Health, based in Danbury, Connecticut, offers analytics and services to Big Pharma and other members of our healthcare scheme. It went public in April 2014, raising $1.3 billion, to provide an exit route for its PE-firm owners, led by TPG. It scooped up €275 million of cheap money in Europe.
Infor, a software company with 70,000 customers in 194 countries, as it says, is owned by PE firm Golden Gate Capital Partners. It sold €350 million in junk bonds.
Other American companies did too. So far this year, they sold a total of €3.28 billion in junk bonds in Europe, the most for this period of the year in the history of the euro.
But this is just the beginning. And another unintended consequence of the ECB’s QE: shifting of junk and risk from the US to the Eurozone – from US bond funds, retirement portfolios, and insurance companies to unwitting Europeans who are turning part of their income over to life insurers to supplement their future retirement income.
This is a godsend for America. It’s like being told by Draghi to ship our toxic waste to Europe, neatly packaged in corporate speak and labeled as “top soil,” to be sold for top euros.
As the ECB’s QE gets going in earnest, junk bond yields might fall further, and buyers might get ever more desperate, until in the end even our energy companies, teetering at the verge of default and bankruptcy, can raise some cheap money from unwitting Europeans who are trying to create a retirement nest egg. It would allow these nearly bankrupt energy companies to pay off and make whole their American investors. Thus they can keep on fracking and producing even more oil and gas that they can continue to sell below the cost of production. It’ll work as long as the hole can be filled with a plentiful supply of nearly free money, which Draghi’s Europe may be insane enough to provide.
The fracking boom in the US started with natural gas. And now it’s destroying its investors. Read… Investors Crushed as US Natural Gas Drillers Blow Up