Negative yields for corporate bonds ahead

Fancy paying for the privilege of lending money to a company? You will soon have the chance to do so. In fact, some investors already saw negative yields for corporate bonds.

Last Tuesday, the yield of Nestle’s bond expiring in October 2016 briefly dipped below zero.

Yes, of course Nestle is the world’s food giant, it’s a solid company and it is rated Aa2 — better than many eurozone periphery sovereigns — and its bonds are therefore more in demand than those of other companies.

It is also true that Nestle is a Swiss company, and Swiss sovereign bonds with maturities of up to 13 years all have yields below zero, according to data from Bloomberg – so maybe investors use the company as a proxy for the sovereign.

Other sovereigns whose bonds have negative yields on various maturities are Austria, Belgium, Denmark, Finland, France, Germany, Netherlands, Sweden.

Will negative yields for corporate bonds from these countries follow suit? According to analysts at Bank of America Merrill Lynch, it is very possible.

Besides Nestle, Deutsche Bahn, Germany’s railway company, could see investors paying for the privilege of lending it money; over in France, global industrial gases supplier Air Liquide’s bonds could soon fall below zero, according to their predictions.

This is happening because institutional investors such as pension funds are desperate to find a safe haven for their money that is liquid enough to be sold in case of need and not very risky.

This is becoming harder amid increasing geopolitical uncertainty and because high quality liquid assets such as investment grade sovereign bonds are in high demand due to regulatory changes, so banks hoard them.

Another reason for why negative yields are becoming the norm is the fact that central banks have bought many sovereign bonds during their quantitative easing efforts.

With the European Central Bank (ECB) joining the bond-buying party next month, the scarcity of safe havens will only accentuate.

What to do about negative yields

There is little doubt that investment grade debt has been the absolute winner of quantitative easing. Data from Bank of America Merrill Lynch show that last week became the 59th week in a row when investment grade bond funds saw inflows, with $8.7 billion going into the asset class.

The ECB’s money-printing is attracting lots of cash to Europe, even despite the stalemate with Greece about how to deal with its debt.

The flows “highlight the chronic shortage of yield in Europe,” the analysts at Bank of America Merrill Lynch noted. All European assets, not just investment grade debt, had inflows in the week that ended on February 4, with the result that Europe saw the biggest inflows of capital ever.

Negative Yields and Europe Inflows

Negative yields in the week with record inflows into European assets. Source: Bank of America Merrill Lynch

Rather than pay to lend money to the safe havens – be it sovereigns or corporate – the Bank of America Merrill Lynch analysts prefer high-yield bonds with a credit rating of “B”.

Inflows into high-yield bonds have “only just moved back into positive territory” over the past two weeks, suggesting that “high-yield is far from being overowned.”

“We like being long growth-sensitive sectors in credit, as a weak euro, weak oil and the QE confidence boos help nudge up eurozone growth,” they said.

The shortage of bonds in Europe will accentuate not just because of the ECB’s buying but also because issuance has been shrinking as governments try to keep their finances in check, banks deleverage and companies find it easier to borrow money.

It may sound like negative yields on corporate bonds are great for the real economy – after all, companies can borrow this money and invest it in expansion, hiring staff, etc.

But it is very unlikely that this will happen. Instead, the most tempting way for companies to deal with negative bond yields would be to just use the money from the cheap debt for share buybacks.

This would boost earnings per share, make shareholders happy and reward executives who have share options. Everybody wins – except for the real economy.

In such an environment, it looks like as an investor you’d be better off forgetting about things like strategy or value added or innovation.

Just buy the shares of companies with negative yields on their corporate bonds –they’ll soon buy back their own shares, boosting the price.


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