The idea that savers pay a bank to keep hold of their money sounds far-fetched – and yet this is the scenario we find ourselves currently facing as fixed income investors.
Many government bonds in countries from Germany to Japan are yielding below zero, with the amount doing so, recently surpassing $15trn. Corporate bonds are starting to follow suit with some debt offering negative yields – both of which once would have sounded impossible.
Policymakers have lowered interest rates in a bid to avoid a deflationary spiral and to spur economic growth, dampening bond yields. This central bank stimulus is arguably distorting markets. Yet fixed income is still attractive as investors continue to seek out high-quality assets that are highly unlikely to default.
It’s this flight to quality that is helping push bond yields below zero. Ongoing concern about the US/China trade war, as well as the prospects for economic growth globally, are prompting investors to seek out safe-haven stocks. In a liquidity crisis, it is far better to hold government bonds than almost any other kind of asset, perhaps apart from cash.
This is an issue facing all types of investors, though pension funds in particular need to be more conservative and think longer-term than others, due to changing demographics which mean increasing numbers of pensioners and fewer people paying into pension schemes. For investors like this, holding government bonds is arguably unavoidable – no matter how low the yields.
Ageing populations also mean more savers and fewer borrowers, based on the assumption that younger people are more likely to need to borrow – which is also an incentive for central banks to keep interest rates low.
Already we have witnessed the so-called inversion of the US yield curve this year – where long-term debt has a lower yield compared to its short-term counterpart – which historically has indicted that a recession is imminent. That said, even when yields are low, we believe fixed income can still be a good way of diversifying and protecting against the wider volatility of equity markets.
So, are negative yields the new normal? These are unattractive from an investment perspective, but perhaps a necessary consequence of the current low and negative interest rate environment.
The world is in a rapid state of flux. The combination of ever-changing geopolitics, shifting demographics and the slowing global economy has meant that bond investors need to be nimbler than ever, and open to new opportunities, in our view.
For example, just as recently as April, Chinese bonds were added to the Bloomberg Barclays Global Aggregate Bond Index for the first time, and other indices may follow.
This could potentially attract vast inflows into China’s bond market, helping support the Chinese yuan, and such a scenario would likely have a significant influence over global bond markets. Over the next decade we could see strikingly different patterns of ownership of government bonds globally – China could become a higher yielding market suitable for those prepared to take on more risk or conversely, we could see Chinese bonds becoming a safe haven for investors. In my opinion at this point, either scenario is possible.
The trade impasse between the US and China – the world’s two largest economies – dramatically underlines the extent to which China has taken an increasing role on the global stage.
The imposition of tariffs from both countries onto the other’s goods caused disruption not just to each other, but to the entire global economy – and in turn has arguably helped accelerate the move to the next phase of the economic cycle.
The trade war has already had an impact on Chinese economic growth, which slumped to its lowest level in nearly three decades during the second quarter of the year. This has global ramifications as China is the largest export economy in the world and the second-biggest importer behind the US.
At the same time, other emerging markets and Asian countries stand to benefit from the imposition of tariffs on Chinese goods – for instance Indonesia could take over some of the manufacturing that takes place in China.
While suggestions that the trade war could be the new cold war are overdone, it is possible the world won’t revert to the same easy free trade it once had. For example, concerns over intellectual property have led to a degree of protectionism that looks set to stay, which could have a lasting impact on global markets.
Perhaps the best way for investors to navigate a world of negative yields is to look at their portfolios differently. The trade war could have negative repercussions for the global economy, particularly if it continues to escalate, and it is not beyond the realm of possibility that the yield on US Treasuries could turn negative. But we believe there could be potential opportunities for investors who look to other markets, especially if those – who are looking for higher quality assets – think globally.
Read more: Change for the better: ESG and fixed income
 Source: Bloomberg, 6 August 2019
 Source: Bloomberg, January 2019
 China second quarter GDP 6.2%, the slowest quarterly rate since 1992