Doug Goodwille from Kayne Anderson speaks to Drew Meredith from The Inside Network on market thinkers.
While a surging gold price is on hold as the world adjusts to a Trump presidency, all the factors that saw its price rise more than 50 per during his first term in office – trade disputes, fiscal deficits and geopolitical tensions – are almost certainly guaranteed the second time around.
Negative-yielding debt and the limitations of benchmarking
Relax, everybody. The world’s mountain of negative-yielding debt has disappeared, with the last holdout – a Japanese government bond maturing in March 2024 – moving into the black in terms of yield last month.
The mountain grew as big as US$18.4 trillion (A$24.5 trillion) in late 2020, according to Bloomberg’s Global Aggregate Index of the debt. Buyers holding these securities to maturity are guaranteed to make a loss.
Negative-yielding debt is not new in Europe and Japan, where governments issue these bonds. In Japan, the interest rate set by the government is below zero per cent. With a negative interest rate, the central bank charges banks for keeping deposits, and it buys bonds to hold itself; this is at the heart of quantitative easing (QE), the unconventional monetary policy that tries to encourage banks to lend out money and stimulate the economy.
Japan was addicted: at one point, Japanese debt accounted for about two-thirds of negative-yielding debt worldwide, with an estimated US$6.5 trillion worth of fixed-rate debt obligations yielding less than zero per cent. Complicating matters was the fact that the Bank of Japan (BoJ) owned most of this debt: by December 2022, the BoJ owned just over 51 per cent of outstanding Japanese government bonds (some of which had become so illiquid they were kicked out of the FTSE-Russell World Government Bond index.)
The Australian government’s debt issuer, the Australian Office of Financial Management (AOFM), joined the trend in December 2020, when an offshore investor bought US$1 million worth of three-month Australian Treasury notes at a negative interest rate of -0.01 per cent.
While that was a micro-sleeve of a $1.5 billion debt offer that was 5.47 times oversubscribed – at a weighted average yield of 0.0099 per cent – it represented a first for Australia.
Investors were willing to pay a premium – and ultimately take a loss – because they needed the safety, reliability and liquidity that government and high-quality corporate bonds provide. Large investors such as pension funds, insurers and financial institutions may have few other safe places to store their wealth.
Negative-yielding debt constituted about one-quarter of global investment-grade bonds outstanding in late 2020, according to Bloomberg data. “And if you look at the sovereign component of the global aggregate index, up to 40 per cent of the sovereign index was negative in yield at one point,” said Chris Siniakov (pictured), managing director and head of fixed income, Australia, at Franklin Templeton. “It was very significant as a proportion of the sovereign space.”
The flow-on effect pushed many corporate bonds below zero in yield terms in the secondary market.
So, who was buying these bonds? As interest rates have risen out of the negative and changed sign, the mark-to-market losses are potentially very ugly.
“A lot of the sovereign buying was central banks, and those positions are still existing, they haven’t been closed out. Unfortunately, there’d be a sea of red in terms of the mark-to-market on those positions,” Siniakov said.
“That’s fine for the central banks; they don’t really have to answer to investors on a month-by-month or quarter-by-quarter basis,” he said. “The mark-to-market being underwater right now is something that central banks can look through. To a large degree it is the same with investors such as sovereign wealth funds and insurance companies, which are regulated to hold assets of a certain kind, to keep a certain amount of capital on their books.
“But these days, the pressure on investors like ourselves, particularly in the public markets where we are marked to market, every tick, every minute of every day, having that sort of outcome in your portfolios would be quite devastating.”
Sovereign bonds are very safe and liquid assets, Siniakov said: banks, super and pension funds, and insurers typically have to own them as a pillar of sound liquidity management. Some institutional investors might also own them because they need to pledge bonds as collateral when borrowing.
Other investors may have decided to hold some negative-yielding bonds as a hedge against deflation – a negative-yielding bond can deliver a positive real return if there is deflation. Some liability-driven investors may have bought negative-yielding bonds to match particular liabilities in the future.
There may also have been investors simply expecting a capital gain as central banks bought the negative-yielding bonds from them, or even holding them because the prevailing foreign exchange conversion made the yield positive.
But any investor taking a benchmark-centric approach would have effectively been forced to hold a portion of their portfolio in negative-yielding bonds. One would expect any active manager worth their salt to criticise that outcome – and even if it’s a free kick for the active players, at the very least it calls for a more common-sense approach to benchmark constraints.
