Expectations that the Federal Reserve and European Central Bank may be getting ready to ease monetary policy to boost economic growth has led to rising prices for risk assets and some curious market anomalies.
While negative yielding debt issued by sovereign borrowers has been part of the investing landscape in recent years, a small number of high-yield bonds (or junk-rated debt) from European corporate borrowers were yielding less than zero earlier this month. Risk premiums, or the spread above safe government debt issued by Germany, for sovereign paper from eastern European countries like the Czech Republic and Poland have also yielded below or just above zero in recent weeks.
Driving some of the chase for yield is the prospect that central banks will further ease already loose monetary policies.
The Federal Reserve has signaled that it will likely cut interest rates at its two-day meeting next week. Meanwhile, the European Central Bank (ECB) meets July 24. A growing band of market observers suggest the ECB could, at least by September, lower its already negative deposit rate and potentially reintroduce quantitative easing through its bond-buying program.
In the U.S., a Fed rate cut of 25 basis points (or even more, some suggest) would represent the first time the open market committee has taken such action since 2007. Like most things, economists, professional money managers and other observers aren’t in agreement if a rate cut is needed at this point.
On the one hand, financial conditions are already loose by historical standards. The Chicago Fed’s National Financial Conditions Index fell to -0.84 for the week ended July 19, a near record low. Negative values for the index have been historically associated with looser-than-average financial conditions.
The nation’s unemployment rate at 3.7% is also still near historical lows, while consumer spending has been strong. Retail sales rose in June for the fourth month in a row and were up 3.4% compared to a year ago.1 And stocks continue to chug along despite what could be the tip of an earnings recession, with aggregate S&P 500 earnings slated to potentially post two consecutive quarters of declines for the first time since 2016.
Within the S&P 500, though, some companies have beaten analysts’ forecasts, and with more money flowing to equities, the march to and beyond 3,000 for the index has been steady thus far in July. Year-to-date, the S&P 500 has gained 19.89% through July 23. The Dow Jones Industrial Average has posted price gains of 17.24%, while growth and technology stocks have propelled the Nasdaq to a 24.36% rise during the same time period.
On the other hand, inflation remains low and U.S. economic growth is expected to slow from the first quarter’s 3.1% pace. The Fed, too, is eyeing up uncertainties around trade tensions and the potential for slowing global economic growth to weigh on the U.S. economic outlook.
The ECB is contending with weakening economic growth in Germany and softer demand for exports from countries within the eurozone. At 1.3%, inflation also remains well below the ECB’s 2.0% target.2
Other than the strong gains in stocks, risk premiums have declined to the point where a growing number of corporate issuers abroad are finding their debt yielding below zero. Negative yielding debt isn’t something new for sovereign bonds issued by developed countries.
Overall, the volume of debt outstanding yielding less than zero is nearly $13.0 billion, according to Bank of America Merrill Lynch. But as Bloomberg notes, it has spilled over into the euro-denominated junk bond market, with 14 issuers (as of this July 9 report) trading with a negative yield.3
Emerging market borrowers and companies are also flocking to Europe to raise funds. Euro debt sales by developing nations and firms amounted to $58 billion year-to-date. That compares to 2018’s total volume of $77 billion, according to this Reuters report, which cites data from Dealogic.
“This is clearly a reflection [of] the very ample liquidity conditions we experience right now, because of these monetary policy accommodations, and even more so for the expectations of additional monetary policy accommodation,” Marcelo Assalin, head of emerging market debt at NN Investment Partners, told Reuters.4
1-U.S. Census Bureau (2019, July 16). Advance Monthly Sales For Retail And Food Services, June 2019 [Press Release]. Retrieved from: https://www.census.gov/retail/marts/www/marts_current.pdf
2-Eurostat. (2019, July 17). Annual inflation up to 1.3% in the euro area. Stable at 1.6% in the EU [Press Release]. Retrieved from: https://ec.europa.eu/eurostat/documents/2995521/9984108/2-17072019-AP-EN.pdf/e507c971-54f9-4c0f-96d6-d619a8a912aa
3-Benitez, L. and Vossos, T. (2019, July 9). Sub-Zero Yields Start Taking Hold in Europe’s Junk-Bond Market. Bloomberg as posted in Yahoo Finance. Retrieved from: https://finance.yahoo.com/news/sub-zero-yields-start-taking-082405487.html
4-Strohecker, K. and Arnold T. (2019, July 24). Negative yields see record euro borrowing from emerging markets. Reuters. Retrieved from: https://www.reuters.com/article/emerging-bonds-issuance/negative-yields-see-record-euro-borrowing-from-emerging-markets-idUSL8N24O47J
Sources for Market Data:
Chicago Fed’s National Financial Conditions Index:
Chicago Fed’s National Financial Conditions Index Series:
Dow Jones Industrial Average:
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