Bonds In Conversation : Only The Devil May Care – Negative Rates Nightmare

No surprises that one of the most read articles this week pre-ECB historic negative rates decision has been The Unstoppable 100 Trillion Bond Market Renders Models Useless.

It is true that valuation models do not work anymore as investors overlook all angles in favour of just YIELD. And the biggest human bias is in the short term memory, quite forgetting events of a year ago and all the flash crashes we have had in the HY space.

One thing I would like to point out to readers is that we should not confuse negative rates with QE. QE is a liquidity injection, negative rates do not change the money supply in the system.

Yes, we would expect that banks will not leave spare balances with the ECB going ahead, or be penalised for it but I do not think it is going to spur them to make risky loans instead.

This is because the better the credit rating of the bank, the more expensive it will be to load up on high risk loans and bonds which makes -0.1% a safer option especially in times like these when credit valuations are at extremes.

The better option if I were managing the balance sheet of a bank would be to load up on wealthy clients and lend them money to take these risks for me which is more profitable for the bank in terms of capital at risk.

And that appears to be a big trend especially in Singapore.

Competitive pressures amongst banks have seen many of them caving to assign lending values to bonds that were impossible to borrow against in the past. But the risk is in the client and his net worth and not the collateral and thus, banks are becoming increasingly comfortable with the arrangement.

Credit spreads around the world have mostly compressed and Irish bonds are yielding under US treasuries for the first time since 2007. Besides that, we are seeing record low yields in Spain, Italy, Belgium and Ireland 10Y bonds which are a direct result of the -0.1% ECB deposit rate.

Prices are maginally lower on the week for USD papers because of the 10Y UST sell off this week after a year to date low in yields on 28 May. That is the big question mark for most investors today as we head into the all important US Non Farm Payrolls data tonight where 215k new jobs are expected to be created.

I read somewhere about regulators’ concerns on excessive risk taking in markets and the devil may care attitudes with the current low volatility environment. It is indeed a self inflicted concern because they are busy playing Mr and Missus Nice.

The analysis is that there is a potential for regulators to sound sterner warnings in the days ahead that could spark hedging activity.

I tend to agree with that.

I noticed some of my friends busy taking profits on their Indian bond investments both in local and hard currencies after the fantastic election run. Sore losers are rushing into China papers and equities hoping for the same windfall.

In Singapore, we saw an active trading week with customers piling into the recent Yanlord paper as well as the Genting and Cheung Kong perps which were previously  shunned because of their less attractive step up options.

The new 3Y issue out of Kris Energy managed to rally 1% within 2 days as investors were sold on Keppel Corp’s stake in the company.

Given that interest rates have risen on the week, the recent issues are still holding to their price gains which denotes various degrees of spread tightening.

Indeed, only the devil may care.

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