Macroscope | Negative European bond yields a case of reality stranger than fiction
The addictive risks of QE in the long term could have serious implications for European markets and investors, especially if bond bubble bursts
Sometimes reality can be a lot stranger than fiction and completely at odds with logic. Who would have guessed that rational investors would be happy to lap up risky European sovereign bonds offering negative yields in the face of significant market risks?
Europe's government debt market seems a very surreal place with investors throwing caution to the wind and chasing vanishing bond yields. It is a market supercharged by the European Central Bank's quantitative easing programme in support of the euro zone's spendthrift bond-buying jamboree.
It is creating all sorts of distortion and disorder for Europe's government debt market, causing headaches for policymakers and potentially piling up massive problems for the future. It is not only submerging a significant portion of the euro zone debt curve into negative yield territory, but it is also throwing the rule book out of the window in terms of pricing underlying credit risk.
It is not just highly prized triple-A rated European nations like Germany that have seen significant portions of their yield curve dipping into negative territory. Now some of the former distressed euro zone nations that went through humbling bailouts after the 2008 financial crisis are joining Europe's negative yield club. Portugal is the latest recruit.
In the thick of Portugal's bailout crisis in May 2011 it would have been inconceivable that four years on the country would manage to sell government debt to global investors for a negative yield. Yet Portugal staged a major coup last week, selling €300 million (HK$2.5 billion) of six-month paper at an average yield of minus 0.002 per cent. It was the first time it had sold paper at a negative yield. The auction was oversubscribed by four times, despite Portuguese debt being below investment grade.
It seems investors buying Portuguese paper at negative yields have short memories. Short-dated paper soared more than 20 per cent at the height of the 2011 debt crisis. Thanks to QE, this all seems to have been buried into the market's deep subconscious.
It bears all the hallmarks of "irrational exuberance" gone mad. Europe's bond-buying frenzy is not being driven by rock-solid fundamentals but by a QE-fuelled surfeit of investor demand over market supply.