TwentyFour Asset Management
As more government bond curves around the world join the select group trading at negative yields, we are seeing a spike in ‘Japanification’ headlines in the press.
There are two angles to this term. The first is a macroeconomic one, where the scenario features very low growth and inflation, high government debt, and current account surpluses that should give confidence the debt pile can funded domestically. In addition, extremely loose monetary policy keeps the yield curve flat and pretty static, trading at near-zero or negative yields. The hope is that these actions ultimately bring back growth and controlled levels of inflation, something that as we all know has not really happened in Japan.
The second angle, and the one we’ve seen much more of in the press, is the ‘Japanification’ of financial assets. This is a simpler analysis, which essentially says the negative yields prompted by extremely accommodative monetary policy drive most financial assets higher in price. In other words, it’s less about the macro and more about the technical picture.
There are currently just over $12 trillion worth of bonds trading with negative yields, which is actually lower than the peak of $14 trillion around a year ago. However, as Bank of America analysts noted in a report last week, the stock of negative-yielding bonds in sectors such as sovereign, quasi-sovereign and covered bonds is virtually back to its peak. Credit is the one that’s lagging.
This is understandable given credit is the riskier end of the spectrum and we are in the middle of a recession, but we think it is only a matter of time before it joins in the spread compression.
Within credit one interesting case is the UK, which only joined the negative yield club a few weeks ago. When yields are negative in the risk-free asset of a given currency (like sterling, for example) it is reasonable to expect investors will seek to move to assets that have positive yields in that currency. At the same time, the Bank of England is purchasing Gilts in large quantities, thereby ‘replacing’ that bid and keeping the curve well anchored. On top of this, we have the Brexit premium we see built into sterling credit spreads. As we’ve said previously, the UK is a G7 nation with its own reserve currency, a solid banking system, negative government bond yields and a premium in spreads. For us that looks an attractive proposition.
The Brexit process is far from over and uncertainties remain, but it is hard to dispute that things are slowly but surely moving towards a resolution. Negative UK government bond yields could serve as a catalyst for the Brexit premium to close, partially at least.