The theory of relativity applies to finance!

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In recent weeks there have been large volumes of issuance of corporate bonds in the primary market confirming a healthy appetite among investors for short-dated, corporate bonds. The rational for this phenomenon is not obvious since the bonds being issued are of relatively short maturity (just a few years) and offer near-zero yields in return for the sort of credit and volatility risk that made itself felt in February this year (see exhibit 2 below)! While such issuance may, at first glance, seem incoherent in absolute terms, in relative terms it makes sense: the ECB’s monetary policy has changed the landscape for interest rates -the scale for interest rates how begins at  -0.40% for overnight rates, dragging yields of risk-free AAA rated sovereign debt down to -0.50% and leading to negative yields for maturities out as far as 9 years (in the case of German sovereign debt – see exhibit 1 below).

Exhibit 1: Under water! Yields on AAA-rated German sovereign debt are now negative for all maturities up to 9 years (the red line indicates the level of a 0% yield)

EUR German sovereign curve

Source: Bloomberg, as of 12/04/16

Clearly, under current circumstances finding positive yields in eurozone bond markets is increasingly difficult. For over a year now eurozone central banks have been engaged in the ECB’s bond purchasing programme, buying up sovereign debt as well as covered bonds and securitised securities and pulling down yields to these low levels. As these purchases are paid in cash, the impact of the programme is enhanced by the injection of liquidity into the market – liquidity which is then to be reinvested at a more attractive interest rate. The package of measures announced by ECB on 10/03/16 went even further by declaring that this programme is prolonged in time for an indefinite period and broadened to include purchases of “investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area.”

So, a yield of zero for short-dated debt is an accurate reflection of the market conditions and risk.

Exhibit 2: After rising sharply in February 2016 the risk premium for corporate debt tightened sharply following the ECB’s announcement, on 10/03/16 that it was expanding its programme of bond purchases to include high-grade eurozone corporate debt (exhibit 2 shows the risk premium for the iTraxx Europe 5 year and index comprising 125 equally weighted credit default swaps on investment grade European corporates).

itraxx

Source: Bloomberg, as of 12/04/16

Written in Paris, April 2016. This article is the translation of an article originally published on 11/04/16 in the magazine ‘Option Finance‘ ©Option Finance- 11 April 2016.

Patrick Barbe

CIO Core Fixed Income, Sovereign & Aggregate management team, Portfolio Manager

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