Here's how $1.5 trillion of sub-zero debt vanished globally

Negative rates have been pushing fund managers to scour the world for better yields

The skyline of Frankfurt's financial district. Inflation in the eurozone, driven by rising energy prices and consequences of supply chain bottlenecks, has outpaced ECB forecasts. Getty

The world’s enormous pool of negative-yielding debt shrank by a record 20 per cent in just a day, signalling that negative yields might be a thing of the past if ever-bolder bets on policy normalisation pay out.

In both Germany and Japan, the world’s major bastions of negative rates, five-year yields climbed above zero on Friday for the first time in years. They were once part of a pile of such debt, which has dwindled to $6.1 trillion, a three-year low.

Traders are lifting bets that the European Central Bank will raising its key deposit rate to zero by year-end, while speculation is growing that the Bank of Japan will join developed-market peers in normalising monetary policy. Sizzling inflation is pushing central banks to scrap extreme measures they imposed during the Covid-19 pandemic and that’s fuelling further bets in markets.

“Negative bund yields are going to be a memory soon,” said Althea Spinozzi, senior fixed-income strategist at Saxo Bank A/S. She’s planning to raise her year-end forecast for two-year German yields to about 0.1 per cent after the ECB turned more hawkish on Thursday.

The ECB’s pivot brings it more in line with global peers at the Bank of England and Federal Reserve, which are racing to deal with red-hot inflation. Each central bank is tackling the challenge from an ultra-accommodative base: the BOE hiked for a consecutive meeting Thursday from its all-time trough, while the Fed and ECB’s key rates are still at record lows.

Turning positive

Japan’s five-year yield climbed to zero on Friday for the first time since the country introduced negative benchmark rates six years ago. German five-year yields rose above zero for the first time since 2018.

“Every single central bank last year resisted the notion that inflation was anything other than fleetingly transitory, and now one by one they are being forced to try and play catch up,” said Stephen Miller, an investment consultant at GSFM, a unit of Canada’s CI Financial. “They underestimated what pedal-to-the-metal stimulus can do to inflation and now bond markets are paying the price.”

Pressure in the Japanese market also extended to the 10-year yield, which reached 0.2 per cent, the highest since January 2016. Meanwhile, Australia’s 10-year yields jumped 9 basis points after the country’s central bank upgraded its inflation and employment outlook.

As yields climb, money flows will likely change, too. Negative rates have been pushing fund managers from Tokyo to Berlin to scour the world for better yields, sending ripples through currency markets as they do.

Expectations for faster tightening by the ECB have pushed up a gauge of implied volatility on front-end euro rates to the highest since the region’s sovereign debt crisis.

In play

“The equilibrium for implied volatility on front-end rates should be higher than in recent years, with every ECB meeting now in play for policy adjustments and rate hikes on the radar,” Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence, wrote in a report.

The global economy is facing a major challenge as inflation and borrowing costs rise. The International Monetary Fund last month cut its world economic growth forecast for 2022, citing weaker prospects for the US and China along with persistent price pressures.

“Earlier and faster monetary tightening will constrain economic growth and share markets and result in lots more market volatility as investors try to grapple with how high rates will go,” said Shane Oliver, chief economist at AMP Capital Investors.

Still, JPMorgan Chase strategists, including Nikolaos Panigirtzoglou, note that ending the extreme of negative rates could provide an economic tailwind by reducing distortions in savings rates, capital allocation and the pricing of credit risk.

The Fed

US markets are also grappling with negative yields, except in that case it’s for real rates instead of nominal.

With a lengthy window until the next Federal Open Market Committee meeting in March, Treasuries traders are looking for further signals of how rapidly the central bank will move, both on rates and shrinking its balance sheet.

“The next couple of months are going to see higher inflation prints that leaves the market dealing with Fed policy uncertainty,” said Rick Rieder, chief investment officer of global fixed income at BlackRock.