Wednesday, July 13, 2016

The DM fixed income export - negative yields

One of the leading exports from Japan and Europe to the rest of the world has been negative rates. With both regions solidly negative and trillions of debt outstanding with negative yields, the pull to zero for the rest of the world is strong. Whether central banks or private investors, there is continued demand for positive yielding assets as a store of value and simple carry trade. Central banks are not stupid with respect to running their core portfolios, they want to hold yield and are thus buying Treasuries. Money will flow to safe positive yielding assets.

The Fed has lost control of rates to the degree that any increase will make the US even more attractive to foreign buyers which should further increase the value of the dollar. This will hurt US exports and place more pressure on the loan books that have been dollar funded. The last surge in the dollar pushed EM financial asset lower given the difficulty of many banks/investors to manage their dollar liabilities.  A stronger dollar has negative global implications.

The current spreads on dollar asset are still high as measured by the difference in 10-year spreads since 2009 for leading DM rates.  There have been times since 2009 when these spreads were negative with the acceptation of Japan. A one standard deviation move lower in spreads will still have US rates close to 100 bps or more in both Japan and Germany, and spreads versus the UK and Canada still positive. Money will still flow to the US. 

The growing global progression to negative rates will continue to downward pressure US rates. One of the few mechanisms to stop these capital flows is capital controls which would be a surprisingly strong policy move by any developed country. There is little that can stop this demand for safe positive yielding debt.

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