Still Fishing for a Limit

All that is solid is melting into the air, or that's how it feels since several central banks in Europe have adopted negative policy rates.  Sweden's Riksbank became the latest with today's move (-10 bp).   The President of the Swiss National Bank assures us there is a limit, but it is not at the SNB's -75 bp LIBOR target, which is where the Danish central bank has put its key CD rate. 

Many including ourselves, understood zero to be the lower bound for interest rates.  Once that threshold was crossed, it is not clear where is the real bottom now.  One suspects the hole cannot be very deep as the demand of capital preservation will force investors to look for alternatives.  

At the same time, the interest rate savings for governments by the low and increasingly negative rates help offset the costs of the limited amount of funds really given the debtors (most of the exposure is through guarantees not the actual transfer of funds from say German tax payers to Greece. The decline in interest rates, the fall of the euro and the decline in commodity prices, especially energy, must be seen as a net positive for the euro area.  

European governments sold almost $20 bln of paper yesterday near record low yields and even at negative rates yesterday.  Ahead of today's decision by the Riksbank, investors snapped up the government's 4-year bond sales yesterday, paying the sovereign -5 bp for the privilege of lending it funds.  And investors were tripping over themselves for that privilege.  The issue was more than three-times oversubscribed.  Investors bought around 4 bln euros of German two-year notes; paying the German government 22 bp year to lend it funds, twice the amount it paid last month. 

Portugal sold 10-year 1.25 bln euros of 10-year bonds yesterday.  The yield was a little more than 2.5%.  As recently as mid-October, Portugal's 10-year yield was above 3.6%.    Italy sold 7 bln euros  of 1-year bills at about 0.21%.  This is less than half the yield that prevailed two months ago. 

Switzerland sold 10-year bonds that offered the investors of a little more than a single basis point.  The generic 10-year yield fell to -30 bp on January 26.  The yield rose to almost 7 bp today, the highest since the day after the SNB abandoned its cap on the franc.  

Many people ask why would investors pay for lending funds?  There are several different type of investors that appear to be doing so. 

• Passive bond fund managers who track an index; they seem to have little choice. 
• Investors who think deflation is going to deepen. 
• Investor who expect interest rates to fall further.  
• Investors expect currency appreciation, buying a bond denominated in that currency is one way to express that view. 
• Related to this are investors that believe that there is a serious risk of a collapse of EMU, negative interest rate may be likened to the price of a call option on countries expected to benefit, such as Switzerland, Denmark, Germany and Finland.
• Some investors may find that buying a security with a slightly negative yield is preferable to deposit rate that could be more negative.