For investors, one question dwarfs all the others this week: How low can you go?
The European Central Bank is expected on Thursday to push a key interest rate even further into negative territory, a move that is at once widely anticipated by markets and viewed with trepidation.
Analysts and investors say the ECB’s action likely will drive down government-bond yields, further reducing borrowing costs that are already near record lows in many nations. Stocks and many commodities may extend a rebound from a selloff early this year that was driven by worries over the global economic outlook. The Dow Jones Industrial Average on Friday climbed above 17000 for the first time in two months.
Yet many investors warn that trading will likely be volatile and that markets could be roiled if the ECB provides less stimulus than expected.
Moreover, analysts and portfolio managers said they remain skeptical about the efficacy of negative interest rates in stimulating growth and inflation. Many say they are concerned about unintended consequences, pointing to the global bank-stock selloff that followed the Bank of Japan’s decision at the end of January to adopt negative rates. Others say the Swiss National Bank and others could over time be forced to respond in kind, creating further unpredictable ripple effects.
The anxiety underscores the perceived limits of central-bank stimulus at a time of nearly universal economic weakness.
“The key difference this time is that the market is much less receptive to the idea of the ECB generating inflation than they were a year ago,” said Jack Kelly, head of global government-bond funds at Standard Life Investments.
Many economists expect the ECB to increase its bond-buying program by €10 billion ($11 billion) a month or to extend the length of its program beyond its current end date of March 2017. The bank currently buys €60 billion of mostly government bonds every month.
Adding to this, markets anticipate that the bank will lower the interest rate it pays on overnight commercial bank deposits by 0.1 percentage point in March, to minus 0.4%, investors say.
Yields on government bonds have tumbled this year, reflecting rising prices as investors have shifted into haven assets amid generally soft global economic data. During 2016, 10-year government-bond yields have dropped 0.31 percentage point in Japan, 0.39 point in the U.S., and 0.4 point in Germany.
The U.S. 10-year Treasury yield was at 1.883% late Friday, though that was up from less than 1.6% in early February as recent data have pointed to resilience of the U.S. economy.
While such slim yields may be unappealing to U.S. investors, many foreign buyers see them as a steal. On Friday, the 10-year benchmark government bond yielded 0.234% in Germany, 0.58% in France, 1.48% in the U.K. and negative 0.04% in Japan.
European demand for U.S. debt could help keep Treasury yields down at a time when China and some other large holders are selling and U.S. economic growth remains solid, two factors that would tend to push yields higher.
“Low yields are going to stay with us for quite some time,’’ said Craig Bishop, lead strategist for the U.S. fixed-income group at RBC Wealth Management, which had $264 billion in total client assets at the end of January. ”I don’t think we will see a spike in yields until Asia and Europe can join the U.S. on a solid and stable footing. We are far away from that.”
The flight to haven assets is a symptom of continued uncertainty over the economic outlook and how much further central banks may slash rates to stimulate growth.
Despite the ECB’s efforts to bolster inflation, eurozone consumer prices fell in February from a year earlier, the first fall in prices since last September, data showed last week.
ECB President Mario Draghi has said several times that the central bank stands ready to act further if needed to bolster inflation.
Demand for German government debt is so high that more than two-thirds of those securities eligible for the ECB’s bond-buying program had a negative yield at the end of February, according to Pictet Wealth Management.
That isn’t the case only in Germany. At the end of February, 23% of the debt in the Merrill Lynch Global Fixed Income Markets Index had a negative yield, up from just over 13% at the start of the year. In August 2014, it was less than 1%.
John Bredemus, vice president at Allianz Investment Management, which oversees $700 billion globally, expects further volatility. The bond market has become a hot place for hedge funds and money managers to bet on central-bank stimulus, say investors and analysts. A scramble to unwind crowded wagers could spark sharp yield moves in a short span, they say.
German bonds sold off after the 10-year yield reached a record low near zero in April 2015. The selling pressure rippled into U.S. Treasury debt, leaving many bond buyers with capital losses in the short term.
“The bond market is vulnerable” if the ECB fails to meet investors’ expectations, Mr. Bredemus said. “We have seen this before.”
Source: The Wall Street Journal.
