Economy, Weird

Negative-Yield Bond Universe is $2.35 Trillion!


As part of its €1.1 trillion quantitative easing plan, the European Central Bank (ECB) will buy government bonds due between two- and 30-years, including those with negative yields, President Mario Draghi said in January. The bond buying plan has left $1.9 trillion of the euro region’s government securities with negative yields.

Germany sold five-year notes at an average yield of minus 0.08 percent on February 25, a euro-area record, meaning investors buying the securities will get less back than they paid when the debt matures in April 2020. By the next day, German notes with maturity out to seven years had sub-zero yields — reached minus 0.017 percent. The rates on seven other euro-area nations’ debt were also negative.

The German bond markets are leading this historical phenomenon — 88 of the 346 securities in the Bloomberg Euro zone Sovereign Bond Index have negative yields. Euro-area bonds make up about 80 percent of the $2.35 trillion of negative-yielding assets in the Bloomberg Global Developed Sovereign Bond Index.

The seemingly illogical willingness of investors to pay issuers to borrow their money is neither irrational nor driven by just noncommercial considerations (such as regulatory requirements or forced risk aversion). As the ECB prepares to start its own large-scale purchasing program next week, some investors believe they could make capital gains on such negative yielding investments.

The ultra-low interest rate regime is likely to persist for now and this has caused challenges for banks. A growing number of European banks are now charging depositors for holding their funds.

Mohamed El-Erian commented that there are few analytical models, and even fewer historical examples, to help understand the broader economic, financial, political and social implications of all this — particularly for a global financial system based on the assumption of positive nominal rates. We are truly in unchartered waters. Accentuated by the illusion of market liquidity, this is a world in which small adjustments in probabilities of future outcomes — if and when they occur — could result in sharp movements in asset prices.


El-Erian, Mohamed (2015): “10 Things to Know About Negative Bond Yields”, Bloomberg View, February 27.

Goodman, David and Lukanyo Mnayanda (2015): “Germany’s Negative-Yield Universe Extends as ECB Prepares to Buy”, Bloomberg Business, February 26.

Goodman, David and Lukanyo Mnayanda (2015): “Euro-Area Negative-Yield Bond Universe Expands to $1.9 Trillion”, Bloomberg Business, February 28.


Much-needed Correction Or Dubious Data?


India changed its gross domestic product (GDP) calculations and caught everyone by surprise on January 30th, with the revisions suggesting Asia’s third-largest economy is in much better shape than we thought it was.

The government now will calculate growth based on 2011-12 market prices rather than the previous method of using 2004-05 factor costs. The changes are due to a database that includes more companies, better coverage of rural and urban government bodies, and the inclusion of taxes. Information is also included from stock brokers and exchanges, as well as mutual and pension funds and market regulators.

The new methodology indicates that Indian economy surged 6.9% in the year through March 2014 instead of the previously reported 4.7%, while GDP marginally contracted to 113.5 trillion rupees ($1.83 trillion) from 113.6 trillion. The revision takes India’s growth closer to the fastest-growing major economy in the world, China’s 7.4%.

Although the new method brings the Indian data in line with the International Monetary Fund (IMF) and global counterparts, the extent of upward revision is quite sharp and all future estimates have to be re-calibrated. The consequences of the inability to accurately chart a trend could be immediate. Reserve Bank of India (RBI) is meeting tomorrow to decide whether to cut rates for a second time in three weeks, had earlier predicted that inflation would stay below-target until January 2016, based on  forecast of growth at 5.5% for the current fiscal year.


The Road To Normal Is Proving To Be Bumpy

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Simon Kennedy said that stunning monetary-policy shifts in Switzerland and India sent markets on wild rides, highlighting Federal Reserve Chair Janet Yellen’s November warning that “normalization could lead to some heightened financial volatility.”

Today, Reserve Bank of India (RBI) cut their key interest rate for the first time in 20 months and Swiss National Bank (SNB) abandoned a three-year-old cap on the franc’s gains. Both decisions were unscheduled and, in Switzerland’s case, unexpected. Swiss franc surged 27% against US dollar while the surprise rate cut by RBI boosted benchmark stock indices 2.6%, the biggest percentage gain since May 9th, 2014. These decisions indicate the prevailing divergence in the global economy. Central banks are no longer aligned and they are often a source of volatility.

SNB dismantled the franc’s 1.20 per euro ceiling a week before the ECB’s expected announcement of quantitative easing. That move would intensify upward pressure on Swiss franc, rendering the cap untenably expensive. RBI reduced the repo rate by 25 basis points to 7.75% after weakening of inflation giving them room to support the Indian economy growing half the pace of four years ago.

In the end, central banks showed that they still have the power to stun. Forward guidance has its limits as policy can shift abruptly when economic conditions change and officials still like the odd surprise. Axel Weber, former Bundesbank president and now chairman of UBS Group AG commented “Better an end with a shock, than shocks with no end.”


Deposit Interest Rates Going Negative


The Swiss National Bank (SNB) today imposed the negative deposit rate as the Russian financial crisis and the threat of further euro-zone stimulus heaped pressure on the franc. Switzerland normally sees money flowing into its coffers in difficult economic times. A charge of 25 basis points or one-fourth of a percentage point on sight deposits of commercial banks at the central bank, will apply as of January 22. That’s the same day as the European Central Bank’s first decision of 2015.

The European Central Bank (ECB) cut a key interest rate below zero, the first major central bank to venture into negative territory. The ECB cut its deposit rate to minus 0.1% from zero on June 5, then again to minus 0.2% on September 4, when President Mario Draghi said interest rates had reached the “lower bound.”

Interest rates have fallen below zero before. Negative deposit rates have been used by a handful of smaller central banks in recent years, including Sweden’s, which cut its deposit rate below zero again in July after a 14-month experiment in 2009-2010 at the height of Europe’s debt crisis. Denmark returned to a negative deposit rate in September, though the cut was aimed at protecting its currency rather than stimulating growth. U.S. Treasury securities traded at negative yields during parts of the 1930s and 1940s, and Switzerland imposed negative interest rates in the 1970s as part of capital controls.

The ECB officials say more stimulus is needed to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery.  The cut is part of a combination of measures designed to ensure price stability over the medium term, which is a necessary condition for sustainable growth in the euro area. It’s one way to try to reinvigorate an economy with other options exhausted. It’s an unorthodox choice that the U.S. Federal Reserve Bank and other peers have so far rejected.

The economy of the eurozone is grappling with a shortage of credit and unemployment near its highest level since the currency bloc was formed in 1999. The ECB has particular reason to use negative interest rates. The US Federal Reserve Bank (Fed) and the Bank of Japan have turned to large-scale asset purchases, known as quantitative easing, that create new money to fuel the recovery.

By reducing interest rates and thus making it less attractive for people to save and more attractive to borrow, the central bank encourages people to spend money or invest. If, on the other hand, a central bank increases interest rates, the incentive shifts towards more saving and less spending in the aggregate, which can help cool an economy suffering from high inflation.

In truth, the impact of negative interest rates is uncertain. Proceeding with this move underlines the ECB’s concern and the need for drastic measures to turn around the European economy. It sounds attractive in theory, but it could have unpredictable and unintended consequences. While negative interest rates are normally aimed at institutional investors, in the long-term they can have a detrimental effect on savers, if investors decide to recoup the costs of the rate by levying charges on consumers.

In theory, an interest rate below zero should lower all market rates, thus also reducing borrowing costs for companies and households. In practice, though, there’s a risk that the policy might do more harm than good. Janet Yellen, the Fed chair, said at her confirmation hearing in November 2013 that the closer the deposit rate is to zero, the bigger the risk of disruption to the money markets that help fund banks. A deposit rate cut could hurt banks’ profitability by lowering money-market rates, potentially hampering credit supply to companies and households and reducing banks’ incentive to lend to other financial institutions.

In Denmark, commercial banks aren’t passing on negative rates to depositors for fear of losing customers. When banks absorb the costs themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend.

Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. A deposit rate below zero effectively punishes banks that have extra cash but are reluctant to extend loans to weaker lenders.

Banks are starting to charge their customers for depositing large amounts of euros, passing on fees imposed by the ECB, rather than paying interest. They said that the changing regulatory landscape has made it harder to eat the cost, as they might have in the past. The reversal from paying interest to charging it comes after the ECB started charging 20 basis points or two-tenths of a percentage point, in fees for funds parked at the bank.

Deutsche Skatbank, a division of VR-Bank Altenburger Land, which was founded in 1859, is not the biggest bank in Germany, but it’s the first bank to confirm that retail and business customers with over €500,000 on deposit as of November 1 will earn a “negative interest rate” of 0.25%.

Commerzbank AG is the first major lender in the eurozone to pass this negative interest rate policy on to its institutional clients when they announced it on November 19. Other major banks viz. Deutsche Bank, Bank of New York Mellon, Goldman Sachs, JP Morgan Chase have also decided to selectively pass on the negative interest rate policy.

The latest move by the banks is notable because so many of them are taking the step, giving customers fewer options for moving their money. With the global economy still fragile, negative rates remain a tool that banks could use. Only time will tell whether the outcome of negative rates will in fact be positive.


Detusche Welle, “Commerzbank imposes penalty on big depositors“, (November 20, 2014).

European Central Bank, “Why has the ECB introduced a negative interest rate?“, (June 12, 2014).

Randow, J, “Less Than Zero — When Interest Rates Go Negative“, Bloomberg QuickTake (December 18, 2014).

Richter, W, “The Wrath of Draghi: First German Bank Hits Savers with ‘Negative Interest Rates’“, Wolf Street (October 30, 2014).

Schneeweiss, Z. and J. Schwalbe, “Swiss National Bank Starts Negative Interest Rate of 0.25% to Stave Off Inflows“, Bloomberg News (December 18, 2014)


Iraqi Bonds Gain On Maliki Resignation Optimism

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Iraqi government bonds advanced, sending yields down the most in 11 months, on speculation Iraqi Prime Minister Nouri al-Maliki’s resignation will improve the country’s security situation.

Maliki’s move ends a political impasse and may enable Prime Minister-designate Haidar al-Abadi to pull together a more inclusive government better able to counter Islamist militants advancing in the north.

The financial markets had largely priced in this change as we witnessed a 2.5 point rally in Iraq 2028 bonds during the week. The bonds continued their impressive rally on Friday and the yield on the dollar-denominated debt maturing in January 2028 fell 27 basis points to 6.88% at 6:10 p.m. in London, the biggest decline since September 2013.

The Iraqi bonds joined the continued strengthening we’ve seen elsewhere in Emerging Markets and Russia in particular. The rate decreased 61 basis points in the past five days, the first weekly retreat this month. Yields on the government’s 2028 securities have risen 59 basis points since the Islamic State militants captured the northern city of Mosul on June 10.


Who Buys Bonds With A Negative Yield?

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Bloomberg today reports that German bond gains sent the two-year rate below zero for the first time since May 2013 before the European Central Bank announces its latest decision on monetary policy today. The two-year note rate was at minus 0.002 percent, and touched minus 0.004 percent, the least since May 24, 2013. A negative yield means investors who hold a security until it matures will receive less than they paid to buy it.

Another way to look at it is that Germany is not only able to borrow money from the market but they are earning a small amount of interest on top of it. This rare but realistic phenomenon is being driven by only one thing – fear. Investors in other parts of Europe are so worried about getting their money back that they are willing to pay a little for the peace of mind of knowing that they will get back their full capital later.

Now one may wonder why investors in Europe are willing to pay interest on German notes/bonds when they can buy the US, UK or Australian bonds and still earn some interest and the reason is foreign exchange risk. Investors don’t want to have to worry about changes in the value of the EUR/USD or about the cost of converting their currency back into euros in the future if it means paying a small amount of interest.


Yields On Iraqi Bonds Starts Retreat After Jump

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Iraqi bonds plunged the most in two years after fighters from ISIS, a breakaway al-Qaeda group took control of Mosul.

PriceThe yield on Iraq’s $2.7 billion of bonds due in January 2028 climbed 60 basis points to 7.03% on June 11 after ISIS militants seized the country’s second-largest city, Mosul. It’s the biggest jump in a year on a closing basis. The spread over 10 year US treasuries jumped by 59 basis points to 438 basis points. The yield again climbed 24 basis points on June 16 to 7.50%. It increased to 7.77% on June 19 with the premium over US treasuries shooting up to 506 basis points.

IQ 2028 BondsThe bond yield, however, started a retreat as nation’s army sought to check rapid advance of militants who seized some major cities. The yield declined  by 28 basis points on June 24 to 7.42%. It further declined to 7.26% on June 27, which is 472 basis points higher than US treasuries. The spread over US treasuries was 653 basis points on June 26 last year, the day before the UN decision to ease the sanctions.

The Iraqi bonds have been the best performers in the Middle East and Africa region for the past six months, with 15%, JPMorgan Chase & Co. indexes show.

The International Monetary Fund forecast economic growth at 5.8% this year, up from 3.7% in 2013. Foreign-currency reserves rose 33% in the fourth quarter of 2013 from a year earlier to $88 billion as oil output surpassed Iran.

The issue size of the bond is less than 2.7% of Iraq’s oil export revenue and is just 3% of Iraq’s foreign currency reserve.


Iraqi bond: Yield Tumbled 101 bps

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As per an article on Bloomberg, an unintended consequence of Iraq’s political strife is cheaper borrowing costs for the government.

As per the article, the yield on Iraq’s January 2028 bond tumbled 101 basis points this year to 6.64% on May 22, within three basis points of the lowest since March 2013. The bond has returned 13% in the period, more than twice the average for dollar-denominated sovereign bonds from the Middle East’s OPEC members.

Foreign currency reserves rose 33% to $88 billion in the fourth quarter from the end of 2012 after the nation surpassed Iran as OPEC’s second-biggest oil producer. An impasse over revenue-sharing between the government and Iraq’s self-ruling Kurds is among the disputes that have blocked approval of a record budget of $145.9 billion for 2014.

The yield spread for Iraq’s dollar bonds over the US Treasuries has declined 112 basis points since this year’s Feb. 6 peak to 432 basis points yesterday, according to JPMorgan Chase & Co.’s EMBI Global indexes. The spread between Treasuries and Middle Eastern bonds narrowed by 48 basis points in the same period. Iraq’s spread dropped on May 12 to the lowest since August 2011.

Iraq could buy back the entire bond issue at par with the revenue from 10 days of oil exports. This creates a large margin of safety. A lot can go wrong, and investors can still do very well.

Global Trend

The slid in bond yields is also more of a global trend now. The Bloomberg Global Developed Sovereign Bond Index (BGSV) shows yields declined to an average 1.28 percent, the lowest since May 2013, as those on Austrian, Belgian, French, Irish and Spanish debt decreased to records. Treasury 10-year note yields – the global benchmark – fell this month by the most since January and Japanese yields slid to the least in 12 months.


Detrixhe, J. & Goodman, W. (2014) Bond Rally Sparks Little Joy as Bears See ‘Painful’ Capitulation. Bloomberg News, 31 May.

Razzouk, N. (2014) Infighting a Boon to Iraq Bonds as Cash Pile Swells: Arab Credit. Bloomberg News, 22 May.


Will Libor cease to be the global benchmark?

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The hunt for a credible replacement for Libor – long the most accepted market measure of short-term interest-rate moves – is heating up. Banks are testing alternatives to the London interbank offered rate, which is coming under increased scrutiny after regulators accused banks of manipulating the rate. Libor suffered a fresh blow to its credibility recently, when Barclays admitted that its traders attempted to maneuver the rate and agreed to pay fines totaling $455 million.

Libor is not a market determined interest rate; rather it is a trimmed mean from a survey of banks participating in a survey conducted on behalf of the British Bankers Association (BBA). There are a number of problems inherent in the survey-based Libor calculation. First, there is the stigma associated with a higher than average Libor posting. This stigma results in an under-reporting of Libor. Second, there have been incentives for banks to attempt to manipulate Libor by submitting Libor postings that would alter the trimmed mean. The ethics of such manipulation are materially different from the aforementioned stigma associated under-representative of Libor. Here the manipulation was an attempt to foster Libor rates that enriched trading operations of the submitting bank.

Japan’s Nomura Holdings Inc. and Swiss bank UBS AG are among banks trying out a rate linked to the market for repurchase agreements – GCF Repo Index, which is published by Depository Trust & Clearing Corp., the group that clears and settles financial contracts. Unlike Libor, the GCF index is based on actual, not estimated, rates paid for repurchase agreements, or “repos,” which are a crucial source of short-term funding for many banks. While some say the GCF Repo index might be a better barometer of bank borrowing costs than Libor, others counter that the index isn’t an easy substitute. They say repurchase agreements involve collateral such as Treasurys and are therefore less risky than loans in the Libor market.

Before Libor, banks and securities dealers tended to hedge their short-term interest-rate risk with futures on U.S. Treasurys. While bank funding costs can mirror Treasury rates, they often don’t track well during times of panic, when investors rush away from private borrowers and lend at very low rates to the U.S. government.

There are other measures of short-term borrowing costs, but none of them have become broad benchmarks on the scale of Libor. They include the Fed Funds Effective rate, an overnight rate at which banks lend to one another, as well as Treasury bill rates. Its detractors say the federal-funds rate is subject to changes in the Federal Reserve’s monetary policy. And there is uncertainty about how the market will react when the Fed eventually unwinds the entire monetary stimulus it has in place.

Finding a successor could take years. Libor has been growing in influence as a benchmark interest rate since the 1980s and currently is used to set rates for an estimated $800 trillion of derivatives and borrowings, including loans to consumers, companies and governments. Much like credit ratings, it is deeply embedded in the way financial markets function.


USD Euribor started to rival BBA Libor

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The first USD Euribor was published on 2 April 2012 with a panel of 20 European and international banks, after a 9-month testing period. It was developed by Euribor-EBF and the Euribor Steering Committee following a demand from the market to create a benchmark offering the market the best possible idea of the USD interbank market in Europe. The calculation and publication of the rates is done by Thomson Reuters. This is to rival the BBA Libor.

Every Panel Bank is required to directly input its data no later than 10:45 a.m. (CET) on each. Each Panel Bank is allocated a private page on which to contribute its data. Each private page can only be viewed by the contributing Panel Bank and by Thomson Reuters staff involved in the fixing process. From 10:45 a.m. to 11:00 a.m. (CET) at the latest, the Panel Banks can correct, if necessary, their quotations.

At 11:00 a.m. (CET), Thomson Reuters will process the USD Euribor calculation. Thomson Reuters shall, for each maturity, eliminate the highest and lowest 15% of all the quotes collected. The remaining rates will be averaged and rounded to five decimal places.

All maturities, other than overnight, are quoted for spot value (two US working days) and on an actual / 360 day basis. All market participants shall use the “Modified Following Business Day Convention”, where if the maturity date of a USD Euribor rate falls on a day that is not a “Business Day” the maturity date shall be in the first following day that is a Business Day, unless that day falls in the next calendar month, in which case the maturity date will be the first preceding day that is a Business Day.

Now, it needs to be seen in the future how USD Euribor competes with USD Libor as regards to its acceptability as a benchmark rate. This competition will definitely make both EBF and BBA to maintain the highest standards of governance and internal control necessary to instill confidence among the market players for Euribor and Libor to be used as a benchmark rate. Let us hope that this will bring the days of better pricing ahead.