Good news for bond bulls: as far as some of the world's biggest investors are concerned, negative yields will be a feature of Europe for years to come.
Vanguard Group says the euro zone's sluggish economy, where policy makers are barely halfway to reaching their inflation target, means monetary easing will persist, and sub-zero bond yields with it. Deutsche Asset Management predicts rates on benchmark German two-year notes will climb about 0.2 percentage point in 2017 — just twice the advance in the past month and keeping them well below the zero threshold.
Negative yields sound like a bad thing for investors, but for those who already own a bond, a drop in the rate — which is driven by a rising price — means a profit when it comes time to sell. And even if money managers don't see yields falling much from here, their faith in a sub-zero market shows they don't expect the selloff that started late last year to become a sustained rout, either.
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"We can easily see negative yields through 2020," said Paul Malloy, who as Vanguard's head of European fixed income runs teams responsible for $100 billion of assets. The firm as a whole oversees $3.5 trillion. "As long as you think central banks have credibility and are working toward their mandate, there's not a lot to be concerned about."
Rising U.S. interest rates and Donald Trump's election have prompted some to question the sustainability of negative euro-zone yields. Yet European Central Bank President Mario Draghi has himself spelled out why things are different on his side of the Atlantic.
In a sign that officials are in no hurry to rein in the bond buying that's spurred negative yields, he said after the ECB's January meeting that there's still no sign of a convincing upward trend in consumer prices. Some $2.5 trillion, or almost 40%, of European sovereign securities still yield less than nothing, according to data compiled by Bloomberg.
"We're not going to be seeing any hawkish moves from the ECB," Graeme Caughey, global head of rates at Aberdeen Asset Management, said in an interview at his office on Edinburgh's main shopping street. His company oversees about $385 billion. "Yields are not going to shoot up. They're pretty stuck where they are."
Not everyone agrees. Sandy Nairn, founder of Edinburgh Partners, says the small increase in yields that started at the end of last year will continue — and that he anticipated it. He says he's investing in energy company and bank stocks on a bet that markets will see a rotation from debt to equity.
"We assumed this was coming for a while," Nairn said in an interview. "But it has taken longer than we expected, which has been painful."
A bond's yield is a measure of the bang a buyer gets for his buck, and negative rates mean an investor will get back less than he paid if he keeps the debt until maturity.
Safe Haven
There are many reasons why money managers will stump up for the privilege of lending to governments. Sovereigns are among the world's safest securities and provide a way of conserving capital. And many of the biggest investors don't have a choice because they run funds benchmarked against government debt.
Fixed income "is there to provide a dampening effect against volatility and we can see bouts of volatility in the next few years," said Vanguard's Malloy, whose company owns the world's biggest bond fund.
"We should expect this environment with negative yields to stay for a while," said Oliver Eichmann, the Europe co-head of rates and fixed income at Deutsche Asset, which oversees about $760 billion including bonds with sub-zero yields. The firm sees the German two-year yield rising to about minus 0.5% by the end of 2017. "At least for this year and also into next year, we need to get used to this."
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