Thursday, October 10, 2019

Addendum to a Primer on Negative Interest Rates Part 2: Greek Short-Term Debt Incredulously Auctions at Negative Yields

Click here to read the original Cautious Optimism Facebook post with comments

1 MIN READ - A brief addendum to the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff's Wednesday article on negative yielding European debt.

Earlier this week the Economics Correspondent ran an installment on negative interest rates explaining why European investment-grade (aka not Greece) debt is trading at negative yields. The reasons include inflated demand due to large scale asset purchases by the ECB, commercial banks under pressure from central bank negative interest rate policy, and "bond flipping" by institutional investors who see the trend of central bank negative interest rates going lower and lower.

Regarding the last phenomenon (flipping negative yielding bonds), the COCEA on Wednesday noted: "This is the screwy world that occurs when central banks go negative enough."

Well evidently Europe has already devolved from screwy to downright perverse.

Negative yields are no longer just for safe investment-grade bonds. According to Bloomberg, Greece "the one-time bond-market pariah at the heart of Europe’s sovereign debt crisis, just completed a transformative journey by joining the region’s negative-yield club."

Read Bloomberg article here:

In case you're scratching your head over this news, you're not alone. Jon Day, a fixed income portfolio manager quoted by the article warns that "There remain substantial risks around Greece’s financial position and it remains vulnerable to a significant economic slowdown. Current yields on their bonds do not reflect this risk.”

Current yields are not reflecting risk accurately on the entire continent, one more consequence of central banks plowing recklessly ahead into the radically uncharted waters called negative interest rates. Just a few short years ago Greece effectively defaulted on its debt, needed multiple bailouts from the European "troika," and has still not fully shored up its fiscal position with necessary structural reforms, yet institutions are now paying Greece for the privilege of borrowing their money.

Should Europe go into recession and Greece enter another crisis and again partially default on its debt (which would once again introduce systemic contagion as banks, insurers, and pensions across the continent hold their bonds), expect the usual left-progressive/socialist crowd to once again attack "the free market," financial institutions for their "greed," and the "capitalist" bond underwriters for misrepresenting Greece's financial position and inherent risks.

But anyone with a functioning memory should make no mistake about where the mispricing of risk really originated: the European Central Bank. New Keynesian policymakers forcing interest rates into negative territory across the continent have artificially inflated demand for sovereign debt, and effectively imposed price floors on government paper that would never have paid negative yields in a freer, less radically distorted securities market.

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