These words from Ben Howard, the immensely talented singer-songwriter, ring in my head when I think about how much financial markets have been conditioned to respond to monetary stimulus. While central banks have engineered risk free rates on cash to zero (or negative in some cases), driving investors into risk assets, most spectacular of all has been their pervasive influence in the global bond markets.
Last week, two government bond transactions in particular highlighted the madness of the current central bank dominated world. Switzerland became the first ever country to issue 10-year bonds at a negative yield of -0.055%. Investors are willing to pay the Swiss government to hold their money for 10 years! Even the Japanese, who have been battling deflation for 15 years, never issued 10-year bonds at negative yields.
The second transaction that I found noteworthy was the Eurobond issued by the Mexican government, €1.5 billion with a maturity date of 2115 and a yield of 4.2%. Obviously the first thing that is eye catching is the 100 year maturity profile of the bond, we’ll all be long gone by the time this bond will be paid back, assuming the Mexicans don’t default between now and then. However, more striking for me is the yield required to cover the plethora of risks. 22nd century bonds sound cool, but that’s some serious duration risk (rising European interest rates would be devastating on the capital value of this bond). There is also currency risk to consider, a declining Peso would make it more expensive to finance foreign currency liabilities.
In 2008, I bought a 2-year German government bond for clients with a yield of 4.25%. It just shows how much the world has changed in seven years, when the Mexicans can borrow money in euros for 100 years at a yield of 4.2%! Still, there seems to be no end to the madness in sight. If central banks continue to purchase bonds and drive yields lower, the reach for yield will attract more borrowers to issue bonds, at record low rates.
Of course, the longer monetary policy continues to drive asset prices higher (equities, bonds, property, etc.), we can be sure that the madness will end in tears.