The Daily Update - Negative Emerging Market Yields

Croatia, Italy, Lithuania, Bulgaria, Latvia, Portugal, Spain and Slovenia all now offer negative yields in the 2-year region of their euro yield curve. Croatia, which today remains only a fraction of a basis point in negative yield territory, is BBB- and well into the Emerging Market category, as would be many of the other recent additions to the negative-yields-club. The total amount of negative-yielding debt in the Eurozone alone surpassed €5tn earlier this month and is now well above the previous peak of €4.4tn back in Q3 of 2016. Around €3.5tn of this is from Germany and France but the remaining €1.5tn spans peripheral Eurozone and other European bonds.

Globally, negative-yielding bonds tallied to touch $13.5tn recently, with countries like Netherlands, Finland, Germany, Sweden and Switzerland now having between an 80 to 95% share of their government debt offering negative yields. A favourite of these is perhaps the Swiss 20-year zero-coupon bond trading at CHF 101.89. Paying 1.89% upfront to lock-in the next 2 decades of inflation risk (effective yield is -0.116% over the 20-year period) certainly is a sobering prospect for Swiss investors needing somewhere safe to put their capital. Other not-quite-negative favourites include Austria’s century bond yielding just 1.15% and North Macedonia’s EUR 2025 BB junk-rated bond offering just 1.55% yield to maturity. This new reality echoes an April-Fool’s article in the Wall Street Journal from many years ago, recommending the US Treasury issue zero-coupon perpetual bonds (which doesn’t seem that much less attractive than those listed above).

In such a low yielding environment, screening for value becomes vitally important. Avoiding poor risk-adjusted-returns means steering clear of negative yields, but it also means avoiding junk when it is trading at prices that are anchored – not by fundamentals – but by loose association to core-European low-risk debt. In many ways, this follows the similar pattern seen between 2000 and 2008, in countries like Greece that adopted the Euro, when the market overstretched to maintain historical yields: pulling Greek 5-year yields steadily down from around 7% to 3% (before of course reversing up to 40% by 2012).

Arguably, one better risk-adjusted option for increasing yield in the EUR bond space is in oil-rich nations that are strategically tapping the current low yields: not primarily to service their deficit, but to diversify future oil revenue into the global economy. These and other value-driven opportunities still provide a range of positive yielding credits, from high-investment-grade issuers, within countries with little to no Net Foreign Debts. This is certainly preferred to hoping for protection by diversifying across a combination of junk and negatively-yielding assets that have been historically correlated and in aggregate provide near-zero yields. With central banks worldwide already having cut rates over 700 times in the past decade, they are running low on the necessary power not only to boost inflation – in an ageing and debt-laden world – but will also be weaker in protecting against potential shocks.

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