Feb 272015

Listen to the music of the bond market. That was the first of the bullet points that I presented to speaking clients last week.

The song the global bond market is singing this week is the same as last week: Almost No Inflation, and Very Little Growth.

Germany on February 25 auctioned about $3.72 billion of five year notes. For the first time ever, the effective yield on the notes at the time of issue was less than zero. Not by much, mind you — only eight one hundredths of 1 per cent or eight basis points. A similar auction of five-year notes by Germany in January was at an average yield — positive — of only five one hundredths of 1%.

Why would anyone buy a piece of paper at 100 that will be worth less than that at maturity? In part because the European Central Bank is about to embark on its version of quantitative easing (QE). It will scarf up government bonds and other paper worth about 60 billion Euros a month in an effort to goose the Eurozone’s growth rate. Despite the negative yield, the prices of the notes might rise as the ECB starts hoovering up similar paper.

And paying Germany eight basis points is cheaper that what banks must pay to keep deposits at the European Central Bank, 20 basis points a year. Switzerland’s central bank is also charging banks for safe-keeping deposits, in what is know as NIRP (for negative interest-rate policy).

Alberto Gallo, the head of European macro credit research at the Royal Bank of Scotland, told the New York Times this week that negative-yield bonds are the fastest-growing asset class in Europe, with about 30 percent of European sovereign bonds trading at a negative yield

Think again if you think this is just a European phenomenon. J.P. Morgan Chase has begun notifying some corporate customers and hedge funds that their deposits are not welcome. High reserve requirements and the burden of regulation have made such deposits unprofitable. In effect, Chase CEO Jamie Dimon is telling customers, “Pay us if you want to keep money here.”

Negative interest rates are uncharted territory for the developed world’s banking system. As I told my speaking clients last week, I have not seen this movie before. I do not know how it ends.



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