Yoruk Bahceli and Dhara Ranasinghe

LONDON, (Reuters) – When the euro area interest rates became negative in 2014 fixed income specialist Michael Hampden Turner recalls explaining to confused bond investors what they might be charged for lending money to governments.

Investors soon began to pay many countries and some companies to get their cash as central banks tried to save the economy from a series of crisis.

Although Savers claimed that ending the practice of charging interest to borrowers robbed them wealth, by 2020 75% of sovereign eurozone debt listed on Tradeweb’s platform (roughly 6.7 trillion Euros ($7.45 Trillion) – had negative yields.

A decade on, Hampden Turner, formerly at Citi, and now at Russell as fixed income director, has seen borrowing costs rise back to 0%. He now needs to educate his younger colleagues about positive yields.

Hampden Turner stated, “In the past, we were just trying to get people used to it. Now, there’s a whole new generation of traders who have never experienced anything except negative yields.” All of a sudden, that is changing. (Graphic: Euro zone negative-yielding debt pool shrinking fast, https://graphics.reuters.com/EUROPE-MARKETS/zjpqkjzaopx/chart.png)

More appealing returns may attract investors to the region, boost the euro, and ease strains on banks. The most likely losers are corporate and emerging bonds, which were bought in the pursuit of returns.

As it intensifies its efforts to curb inflation, money markets expect the ECB to eliminate negative rates before year’s end.

Tradeweb now has a negative yield on less than one third of the eurozone debt. Deutsche Bank (DE:) The global pool is now less than $3 Trillion, down from $18 Trillion in 2020.

For the first time in 2019, German 10-year bonds yields soared past 0% for January and now stand at 0.6%. The two-year yields have turned positive this week for the first times since 2014 (Graphic: Bund yield: the path out of negative-yield territory, https://fingfx.thomsonreuters.com/gfx/mkt/jnpwekxrkpw/BUND2703.PNG)

NEGATIVEVERDICT

In an experiment to boost inflation and grow, Japan and Switzerland also reduced rates from 2015.

Negative rates are also blamed for the huge increase in debt, inflating stock markets and housing bubbles. They have been bad news to pension funds and insurance companies, who use future bond yields as a way of valuing their liabilities.

Since they can not make money by holding safe government bonds, they are now forced to take more risks: A 2019 IMF paper found that pension plans with large amounts of assets had increased their exposures to liquid, alternative assets, nearly doubling the amount since 2007.

German insurers that offer retirement income have faced a lot of pressure. They are required to keep additional reserves in place by regulators since 2011.

Banks have suffered from negative interest rates reducing profitability and their net interest margins. The Eurozone bank stocks fell 40% in 2014, while Japan’s banks lost 10% when rates dropped below 0% in 2016.

If… interest rate are like a guide for banks pricing power, then interest rates have fallen to a low of 5,000 years in Europe. “So banks’ pricing power was at a 5,000 year low.” Morgan Stanley (NYSE) Chief European Equity Strategist Graham (NYSE) Secker

A CHANGE IN THE EXPERIENCE

Short-term bond yields turned in the positive direction this week and euro zone bank shares rose almost 4%.

Secker estimated that every ECB rate rise could increase lenders’ earnings by 10%, and 20% for those in southern Europe. (Graphic: Euro STOXX Banks vs Euro STOXX, https://fingfx.thomsonreuters.com/gfx/mkt/dwpkrqklzvm/Euro%20STOXX%20Banks%20vs%20Euro%20STOXX.PNG)

Returning to higher yielding assets could lead to capital reinvestment.

Viktor Hjort (OTC) is the global head for credit strategy at BNP Paris. He estimates that insurance companies held 30% of European corporate bonds back in 2016, but only 22% today, a figure that has been pushed aside by the ECB.

According to a BofA survey, long-term investors were the most likely buyers of European credit.

Helene Jolly is head of EMEA corporate debt syndicate, Deutsche Bank. She stated that “if you’re an insurer, the opportunities to invest for you have just expanded dramatically.”

You had to work harder before you could hit your goals. Maybe you were unable to achieve the targets because of your credit rating or maybe it was longer. 

Investors have already started to return to better-quality debt.

Officials noted that thirty-year French, and Belgian government bonds were in high demand following a rise of 1% in January yields.

David Gillard is the head of insurance and regulatory strategy at Allianz Global Investors (DE:). He said that rising yields provide “insurers with underweight rates and spreads a good value point to increase their credit market exposures.”

He said that covered bonds are the most attractive assets for insurers.

This portfolio “derisking” could cause damage to assets that have benefited from negative returns.

Gerard Fitzpatrick of Russell Investments’ fixed income portfolio management said that there was already “at-the margin” risk.

However, with the eurozone rates set to reach a peak of just above 1%, and there being no signs that Japan or Switzerland will raise their rates, it could be years before they are unwinded. This is because inflation-adjusted yields continue to be negative in comparison to emerging economies.

Ludovic, senior portfolio manager at Swiss asset management firm Vontobel, stated that “we’re not going have a party or get out the champagne” because yields are higher than zero.

We need to know where they’re going and not where they are at the moment.