Macroscope | The dawn of negative government bond yields spells trouble for global banks, money market funds

The collapse in the yields on some of the world’s most actively traded government bonds knows no bounds.

On Tuesday, Japan sold 10-year government debt at a negative yield, becoming the second country after Switzerland to issue benchmark government debt with a yield below zero, and highlighting the seeming absurdity of a bond market in which investors are willing to pay to lend money for a decade to the world’s most heavily indebted advanced economy.

While short-term speculators, who hold the bonds for a brief period, accounted for nearly all the buying, the rapidly growing universe of negative yields - which now account for as much as one third of developed market government bonds included in JP Morgan’s sovereign bond indices (up from one-sixth at the end of last year) - is dangerously distorting financial markets and inflicting severe pain on banks and money market funds.

The dramatic decline in bond yields is the result of central banks’ ultra-loose monetary policies.

In the eurozone, Switzerland, Sweden, Denmark and now Japan, central banks have crossed a monetary Rubicon by introducing negative interest rates in an effort to counter deflationary forces and stimulate economic growth.

While markets have hitherto goaded central banks into implementing ever looser monetary policies, confidence in the effectiveness and credibility of these policies took a severe knock in late January when the Bank of Japan (BOJ) joined the negative rate club, triggering a sharp sell-off in the shares of banks - particularly European ones - because of concerns about the impact of negative rates on lenders’ profitability.

Eurozone banks’ stocks are still down more than 15 per cent this year while Japanese money market funds have come under severe strain. Moody’s, the rating agency, warned last week that “the ultimate survival of the industry is in jeopardy.”

However investors are displaying a somewhat schizophrenic attitude towards central banks: while there has been a fierce backlash against negative rates, markets are still clamouring for yet more stimulus in the absence of coordinated multilateral fiscal actions to boost growth in the world economy.