Investors seek long-term debt as yields drop

Two-thirds of government bonds tracked by Bank of America Merrill Lynch’s index yield less than 1 per cent

February 25, 2016 by: Elaine Moore

The three-and-a-half decade long bull market in highly-rated government debt shows no signs of flagging as investors adapt to negative interest rates by buying the longest dated securities available.

On Thursday, the yield on Japan’s 40-year government bonds dropped below 1 per cent for the first time on record, as renewed fears for global growth and expectations of subdued inflation pressures buoyed demand.

Two-thirds of the $26tn government bonds tracked by Bank of America Merrill Lynch’s index now yield less than 1 per cent. That is intensifying pressure on investors such as insurers and pension funds to accept ultra-low nominal returns or accept the added risk of higher returns elsewhere.

“We are moving from a low yield environment to a no yield environment,” said Alex Dryden, global market strategist at JPMorgan Asset Management. “Long-term investors who buy and hold highly-rated government debt have to choose between making a guaranteed loss or taking on more risk. I think investors are still coming to terms with this new reality.”

One month after the Bank of Japan took markets by surprise and followed in the footsteps of the eurozone, Denmark, Sweden and Switzerland by adopting negative interest rates, bondholders have seen prices in government bond markets rise and yields fall to record lows.

In Japan, yields on government bonds with maturities up to 10 years now trade at negative yields. The drop has made longer dated bonds with positive yields more appealing and earlier this week an auction of 40-year Japanese debt that paid a maximum yield of 1.13 per cent was three times oversubscribed.

Government bonds are seen as a haven in periods of economic and market uncertainty, with yields falling as demand pushes prices higher. Long-dated debt also benefits from falling expectations for inflation.

At the start of this week, the rally in haven assets began to slow as major oil producers proposed freezing production and prices for oil rose.

However comments from Saudi Arabia ruling out a deal reinvigorated the rally, sending yields in major government bond markets to new lows.

In Switzerland, where the Swiss National Bank’s deposit rate is currently set at minus 0.75 per cent, the yield on 10-year Swiss government bonds hit a record low of minus 0.41 per cent on Wednesday. In Japan, the yield on 20-year bonds fell to the lowest level of 0.66 per cent.

Faced with negative interest rates, a halfhearted economic recovery and the threat of deflation, Jim Cielinski, global head of fixed income at Columbia Threadneedle Investments, has said he believes demand for credit products will continue to be strong.

Central banks are divided. The European Central Bank has pledged to reconsider existing policy in March, which investors believe will lead to further interest rate cuts and Bank of Japan Governor Haruhiko Kuroda has said the central bank will not hesitate to act if market volatility threatens its efforts to defeat deflation. Swiss National Bank chairman Thomas Jordan, however, has warned that negative interest rate policy may be reaching its limit.