Tensions and uncertainty are boosting global bond markets. Developed markets are witnessing massive capital flows into sovereign debt that are pushing down yields across all maturities. These shifts have caused inversions in which shorter-dated notes pay a higher yield than longer-dated bonds. Inversions often occur before recessions, causing more flight to quality and further depression of yields.
Yields move opposite to prices; as bonds are bid up by eager buyers, their yields fall, even into negative territory. In the current environment, almost 20% of global government debt carries a negative yield; owners of those securities are willing to forego interest payments in order to be ensured repayment of their principal.
Though this is a deviation from typical fixed income investment, it is not without precedent. Before modern financial markets, investors accumulated land, art, gold and other physical assets that were costly to acquire and protect. And the trend toward negative yields is only novel in that nominal yields have now gone below zero. (Real yields have often carried a negative term premium, making risk-free bonds costly after adjusting for inflation.)
Surging government debt has traditionally been fodder for political arguments against further spending. However, issuing debt with negative yields is bizarrely accretive to a country’s fiscal position: The added debt expands a government’s ability to spend while placing no additional interest burden on taxpayers. As long as demand for these instruments remains strong, national treasuries will feel free to continue issuing new debt.
The world’s bond markets are showing clear concern over the direction of the global economy. The risk aversion reflected in negative yields is at odds with the relatively buoyant performance of equity markets, which seem to reflect a much more sanguine outlook. As we mentioned at mid-year, reconciling these two perspectives will be a challenge for investors throughout the balance of 2019.
Carl R. Tannenbaum is executive vice president and chief economist at Northern Trust. Ryan James Boyle is a vice president and senior economist within the Global Risk Management division of Northern Trust. Vaibhav Tandon is an associate economist within the Global Risk Management division of Northern Trust.