Free money

By Guest Blogger Ryan Lewenza

It’s official, we’ve taken a one way trip to crazy town and it’s glorious. That is for European borrowers who can currently borrow money at negative interest rates. Even more insane is the headline grabbing story that the Danish bank Jyske Bank is offering 10-year mortgages at -0.5%! If you can’t wrap your ahead around -0.5% (don’t beat yourself up as I think this might be the first time in history this has occurred), this means that a borrower will play back less than they originally borrowed on the mortgage. Pretty sweet deal for Danish home buyers, but I’m not so certain it will work out for the bank offering these loans.

Today I discuss why we’re seeing negative rates across much of Europe and Japan and whether this trend will make its way west, with Canadian bond yields also going negative.

Danish Bank Offers 10-Year Mortgage Rate of -0.50%

Source: Jyske Bank

Currently, there is roughly USD15 trillion of bonds around the world trading with a negative yield. According to Dynamic Funds this works out to 27% of all secondary debt trading at a negative yield. Most of this is in Europe with Switzerland, Germany, Japan and France 10-year government bonds currently yielding -1.03%, -0.65%, -0.23% and -0.37%, respectively, as an example.

Why is this happening?

International Bond Yields Go Negative

Source: Bloomberg, Turner Investments

As with most things it’s a whole host of factors that are driving bond yields lower.

More recently it’s this darn Trump/China trade war that is clearly starting to weigh on the US/global economy and sentiment. This is leading to a risk-off environment with investors bidding up ‘safe’ government bonds.

Economic growth in Europe and Japan is lackluster to say the least, with Europe and Japan both expected to grow at just 1% this year.

Another critical driver behind these absurdly low interest rates is all the central bank buying through their quantitative easing (QE) policies. Recall, QE is when central banks are aggressively buying their own government bonds in efforts to push interest rates even lower. This has provided huge demand for government bonds and is greatly manipulating the overall bond markets.

The Fed and ECB have ended their QE programs while Japan has maintained them. At last check, the combined balance sheets of the Fed, the ECB and Bank of Japan stand at US$14 trillion, up from US$3 trillion back in 2007.

There are other long-term factors affecting bond yields like aging demographics (more demand for safe bonds) and very low inflation levels.

Below I chart inflation (CPI Y/Y) for Europe and Canada. Nerd Alert! I calculate a 3-year rolling average to help smooth out the data and show the underlying long-term trend. Europe inflation has been declining steadily since 2013 and is well below Canada’s inflation rate. Currently, inflation in Europe is running at 1.1% versus Canada at 2%. This is one reason why I believe Canadian bond yields are unlikely to go negative.

Canadian Inflation Running Hotter Than Europe

Source: Bloomberg, Turner Investments

Additionally our economy is growing at a faster rate than Europe and our central bank looks to be holding rates steady while the ECB is considering cutting rates and embarking on another round of QE, to help boost growth and inflation in the region.

For these reasons I believe it is unlikely that we will see negative interest rates in Canada.

Now having analyzed the financial markets for nearly 20 years and made countless calls and recommendations (some of them terribly off the mark), you always have to look at the other side of the argument to see where you could be wrong. In this case, if the global economy were to experience a severe economic recession (not our base case) then Canadian bond yields could go negative.

Let’s hope it doesn’t come to that!

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.