Good Luck ‘Keeping Your Head Above Water’: Almost Nothing Yields More Than 1% Across The Pond

One of the most interesting things about interacting with the general investing public by way of writing for public consumption is how often I’m reminded that “average” (whatever that means) investors aren’t generally well apprised of key market dynamics.

I use the word “interesting”, because “surprising” wouldn’t work. Regular people (whether investors or otherwise) aren’t very inquisitive and, thanks to the fact that we’ve become a society that everywhere and always eschews real analysis and thoughtful engagement in favor of clickbait, 140-character hot takes and seconds-long soundbites, it’s not realistic to expect most people to know much, even about things they’re ostensibly interested in.

Given that, I wasn’t wholly surprised earlier this week when a commenter expressed incredulity at the idea that ~80% of Germany’s bond market is negative-yielding. To be sure, negative bond yields don’t make a lot of sense intuitively, which means that a time traveler from the pre-crisis era would be forgiven for marveling at the prospect of $13 trillion in negative-yielding debt. But, if you’re an investor and you’re not from the past, you should be at least cognizant of the extent to which a larger and larger share of the world’s fixed income markets trade with negative yields. If you don’t know that, it almost by definition means you don’t understand why assets like equities and corporate bonds have performed so well. In other words, it means you don’t really understand what’s going on, to speak frankly.

Read more: Some ‘Mind-Boggling’ Numbers From The World Of Negative-Yielding Debt

2019 has, of course, been defined by a renewed commitment to accommodation by central banks amid mounting worries about the fragility of the global economy late in the cycle and amid a worsening (and seemingly intractable) trade dispute between the US and China. That dovish pivot and the growth jitters which necessitated it have led to a surge in the global stock of negative-yielding debt, which helps to explain the across-the-board rally in risk assets.

With safe havens now effectively taxed, money that would have been content to loiter in the risk- free world will find its way to riskier assets. That’s the hunt for yield – the mad scramble out the risk curve – the frantic chase down the quality ladder. As BofA’s Barnaby Martin puts it, “‘tourism’ across financial markets will run rife” as a result, just like it has in the past.

On Friday, Martin and his colleague Ioannis Angelakis are out with their latest weekly European credit derivatives strategy piece, and the marquee chart drives the point home further.

It is difficult, they note, to “keep your head above water” in Europe. And not just with regard to risk-free government and quasi-sovereigns. “Negative yielding assets are growing rapidly”, Angelakis writes, adding that “within [the] high-grade space 1-3yr yield is now almost zero (only 6bp) and 3-5y yield is ~30bp”.

Here’s a remarkable chart which shows, to quote the header, “hardly any IG paper in Europe is above the 1% threshold”.

(BofA)

The other thing you should note about that chart is that where you can get more than 1%, the market is risky and not very large. That, in turn, means you either take on more duration or you accept paltry (or negative) yields. Angelakis and Martin underscore this.

“Extending duration amid falling inflation expectations is the only way to add yield without adding ratings or subordination risk”, they note, on the way to describing the chart above as follows:

There are not enough assets out there to provide 1% yield. In the high-grade space the options are scarce: 10y paper, sub insurers, corporate hybrids and AT1s. There is hardly anything that yields above 1% in the senior space with less than 10yr of duration. Actually 89% of senior paper with duration of less than 10years is yielding below 1%. No wonder that under-owned duration will do well going forward.

There is, of course, much more to Angelakis’s analysis than that – it’s a strategy note, after all. But for the legions of everyday investors who, based on my experience, still do not fully appreciate the prevailing dynamic/market zeitgeist, let the above serve as a helpful Cliffs Notes version.

Oh, Angelakis also rolls back out a chart we’ve discussed here before. The visual below essentially illustrates how central banks, through forward guidance, have kept rates vol. suppressed, thereby ensuring geopolitical turmoil doesn’t end up translating into the kind of market events that would force an ugly cross-asset unwind.

(BofA)

Read more: The Central Bank Put Is Still There, But ‘Politicians’ Implied Vol.’ Has Exploded