Debts with negative yields hit staggering US$17 trillion: BIS report

London

GLOBAL sovereign and corporate bonds and other debt that traded on negative yields have reached a staggering US$17 trillion in recent weeks, according to a new report released by the Bank for International Settlements (BIS) on Sunday (Monday morning, Singapore time).

"A growing number of investors are paying for the privilege of parting with their money," said Claudio Borio, head of the BIS' monetary and economic department. "Even at the height of the Great Financial Crisis (in 2008/2009), this would have been unthinkable."

He added that the total amount trading at negative yields accounted for as much as 20 per cent of global gross domestic product.

Of late, bond yields have risen slightly above their early September lows. But the amount of bonds at negative yields remains excessive so "there is something vaguely troubling when the unthinkable becomes routine", Mr Borio said.

Nations with short- and long-term bonds on negative yields include Japan, France, Germany, Belgium, the Netherlands, Switzerland and Sweden.

Countries with short-term rates that are negative and long term bonds that are slightly positive include Italy, Ireland, Spain and Portugal.

Last week, about 50 per cent of negative-yielding bonds were denominated in euros, 40 per cent in yen and a negligible fraction in US dollars. In contrast, more than 40 per cent of bonds with a positive yield were denominated in US dollars.

The question is why investors, banks and other lenders are prepared to accept negative interest rates on bonds and other loans. The reasons are a flight for safety as investors fear recession and volatile equities and action from central banks to ward off a downturn.

Both the European Central Bank (ECB) and the US Federal Reserve have slashed rates recently. Moreover, the ECB has decided to extend quantitative easing (QE) by buying bonds from banks and other financial institutions.

These purchases raise the prices of bonds and cause yields to slide into negative territory. The money used to buy the securities flood the financial markets.

Unsurprisingly, global markets have been volatile. Equities have slid because of worries about the US trade war with China and subsequent slowdown in the world economy.

Brexit and, more recently, the attack on Saudi oil fields have also raised the risk profile of equities. Downturns, however, have been brief as equities recovered after developed and emerging nations' central banks continue to push down rates and ease money.

"Markets oscillated. Trade tensions pushed them down; monetary policy propelled them up," Mr Borio said. "But as this push-pull game went on, bond prices had only one direction to go. They rose, and yields continued their downward glide, reaching a new nadir."

As the global economy weakened, financial market participants once again turned their attention to the inversion of the yield curve: long-term rates falling below short-term ones.

"This closely watched indicator of a future recession, in turn, fuelled financial market concerns, arguably pushing long-term rates down and inverting the curve further," the latest BIS quarterly report said.

The Switzerland-based BIS said that central banks' monetary easing has distorted financial markets so that the indicator has become less effective in predicting the future.

"That said, the credit standing of non-financial corporations, in general, and the surge in leveraged loans, in particular, represent a clear vulnerability," the BIS report said.

"On the back of aggressive risk-taking and a search for yield, a growing portion of these bank loans to highly indebted firms have become the raw material for structured securitisations, known as collateralised loan obligations."

The BIS fears that "there are close parallels with the infamous collateralised debt obligations, which re-securitised largely sub-prime mortgage-backed securities and played a central role during the last global financial crisis.

The BIS fears that losses on these asset classes and leveraged loans could amplify any economic slowdown.