LONDON (Reuters) - The growing acceptance of negative interest rates - where investors effectively pay for the privilege of lending - has reached “vaguely troubling” levels, the Bank for International Settlements said in its latest report.
The recent switch back into support mode by top central banks including the U.S. Federal Reserve, the ECB and China’s PBOC has swollen the amount of bonds trading at negative rates to a record of more $17 trillion.
The BIS, known as the ‘central bankers’ bank’, noted that was equivalent to roughly 20% of the world’s GDP and had brought markets to a point that wouldn’t have been thought possible even at the depths of the financial crisis a decade ago.
Most government debt rates in Japan and Switzerland have dived into negative territory. Yields are sub-zero in Germany and the Netherlands for up to 25 years and even in countries with lingering concerns, such as Italy, short-term yields are negative.
“There is something vaguely troubling when the unthinkable becomes routine,” said the head of the BIS’s Monetary and Economic Department, Claudio Borio.
There was an acknowledgment too that the latest flurry of rate cuts had further depleted the already-limited firepower that some central banks had left.
Earlier this year the BIS had appealed to policymakers to use their remaining ammunition sparingly. The slowdown in global economy since then, however, in the wake of the U.S-China trade war and other stresses, has triggered a renewed wave of easing.
“Should a downturn materialize,” Borio added, “monetary policy will need a helping hand, not least from a wise use of fiscal policy in those countries where there is still room for maneuver”.
Dive in global bond yields -
BIS researchers also examined another related factor that has spooked markets this year: the ‘inversion’ of the U.S. and other bond yield curves.
Inversions are where investors start paying more for a long-term bond than a shorter-term one and have historically preceded recessions.
The BIS said this time though markets’ reaction function may have been complicated by exceptionally low ‘term premia’ - the extra return investors demand to compensate for the risks associated with holding long-term bonds. This premia has been pushed down since the global financial crisis because of strong demand for bonds from central banks, pension funds and insurance companies that tend to buy and hold bonds.
It also added that other traditional recession indicators, such as ‘low near-term forward spreads’, ‘stretched excess bond premiums’ and ‘elevated financial cycle’ measures “do not yield a clear consensus on recession risk”.
It also repeated a warning about a surge in leveraged loans known as collateralized loan obligations (CLOs) which have close parallels with the troubled loans at the heart of the U.S. subprime crisis.
Safety measures put in place since mean the risks are nowhere near as pronounced but they do “represent a clear vulnerability” that could cause problems, the BIS said.
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Term premia dropped to historic lows -
Reporting by Marc Jones; Editing by Andrew Heavens
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