The BoJ’s and ECB’s quantitative easing (QE) policies and negative key rates have nudged bond yields into negative territory. About 80% of Japanese sovereign debt is now trading at negative yields, and about 50% of euro zone sovereign debt (with, obviously, very broad differences between individual euro zone countries). It is now abundantly clear that these two very large markets are “contaminating” other sovereign debt markets and, in particular, the US Treasury market.
One of the most remarkable consequences of low bond yields is that investors’ are increasingly seeking out yields, particularly outside the euro zone. Each basis point counts. A significant share of liquidity freed up by the ECB’s QE (€240bn per quarter beginning in Q3 2016) is being used to buy up foreign bonds. In Q1 2016, euro zone investors bought a net €152bn in foreign bonds, including €79bn in US bonds (unprecedented).
Portfolio outflows in the euro zone and Japan are now very heavy and are offsetting the significant current accounts surpluses (which are hovering respectively around 3% and 4% of GDP) and even more. This is keeping the euro and yen artificially low (incidentally, this also raises the matter of what would happen if, one day, the ECB and BoJ would like to stop their purchase programmes).
Low interest rates are raising lots of questions for the Fed. The FOMC’s June minutes, for example, contained this sentence: “Actions by investors to shift their portfolios away from very low-yielding foreign sovereign debt was cited as adding to the downward pressure on U.S. yields.” And it is not the outlook for Fed tightening that will help raise US long yields significantly. The release of Q2 US growth figures and the downward revision of Q1 figures dampened the mood considerably! Year-on-year growth was just 1.2% in Q2, well below its potential.
What happens when the euro zone and Japan export their low interest rates…
DRUT Bastien , Fixed Income and FX Strategy