How negatives rates are having a rising impact on credit markets

We reckon the rising risks of the policy of negative interest rates.

Money flows into riskier segments of the financial markets, in particular sub-investment grade bonds and emerging market bonds/equities as investors seek to achieve a minimal yield.

While we advise our clients to avoid the distorted EUR bond market, we continue to participate from the implied gains of emerging bonds.

But we follow the situation carefully; the valuation of the latter has improved faster than the fundamentals have improved.

We regard the level of government bond yields and high-grade non-financial corporate bond yields as unsustainable – for two reasons.

First, European banks need a massive amount of government debt and non-financial corporate bonds to fulfil the regulator’s liquidity coverage ratio.

The European Central Bank has driven the yield of most of these assets down or even into negative territory. We are concerned that European banks are thus generate losses on the holdings they need to satisfy the LCR requirements.

This cannot go on forever. Second, we are optimistic that the global economy will continue to grow and that inflation rates will normalise. In such an environment, it is a question of time only for bond yields to move higher.

As outlined above, we regard the situation as unsustainable.

That said, the “search for yield” will go on for some time. Investors ready to react swiftly on changes in the money flows can still buy emerging market debt, both in hard currency and local currency.

Bank stocks, on the other side, will remain under pressure as long as the compression of interest margins and the negative return on liquidity continues.

Markus Allenspach is head of Fixed Income Research at Julius Baer

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