It’s no secret that the quantitative easing (aka money printing) policies of the US Federal Reserve and the European Central bank has, to put it lightly, not been very successful.
We’ve talked about this before, but to reiterate, there has been no evidence that QE works. Inflation has remained low and real economic activity is faring even worse.
In addition to ballooning central banks’ balance sheets to insane levels, these monetary easing policies have also led to a severe mispricing of risk. As the policies pushed yields ever lower, investors began to search out for greater yields in ever riskier investments. This partially explains our over-inflated stock market today, it’s the only way to get anything above marginal yields.
But if you think the situation over here is bad, then you haven’t seen the situation across the Atlantic yet. While the Fed is at least attempting to unwind QE and tighten up monetary policy (whether or not this will be successful is another matter), the European Central Bank continues to play it fast and loose.
Here’s how bad the situation has gotten:
Euro junk bond yields are now lower than US 10 Year Treasury yields. You got that right — as of October 9 2017, Euro junk bonds, bonds that aren’t even investment grade, have lower yields than 10 Year US Treasuries, considered some of the safest assets in the world.
Take a look at the two charts below:
Source: CNBC
Source: St Louis Fed
As you can see, 10 Year US Treasuries are standing at 2.35% while Euro junk bonds, as measured by the BofA Merrill Lynch Euro High Yield Index are standing at 2.29%. All bonds in the latter index are below investment grade, yet their average yield is 6 basis points lower compared to 10 Year US Treasuries.
This isn’t rational, not in any sense of the word. Whatever the criticisms leveled against the Federal Reserve and the US Treasury, there is no way to that this should be the case. This is nothing short of a blatant and fundamental mispricing of risk. Just a symptom of how monetary easing policies have led to such a low yield environment that European investors have to pump so much money into junk bonds.
Just how bad is the low yield environment in Europe currently? Oh, it’s bad alright. For instance, did you know that a significant amount of European sovereign debt have negative yields. This means that if you held these bonds to maturity, you would actually lose money! Not even two weeks ago, Ireland just sold EUR4 billion worth of bonds at a negative yield. And the current stock of negative yielding bonds? Well over $6 trillion dollars, and that’s a decrease from a peak of over $12 trillion!
With yields that low, European investors simply cannot keep up with inflation, leading to extreme yield seeking behavior and a fundamental mispricing of risk. Even though the pile of negative yield debt is shrinking, the amount still remains larger than the combined bond markets of Italy and Germany combined!
With this kind of bond mispricing, it’s no wonder that so many people are souring on the bond market as a whole. Bill Gross, the bond king has stated that the pile of negative yielding bonds is a supernova waiting to explode. Deutsche Bank CEO John Cryan has said that negative rates have fatal consequences. And a fund manager from Aberdeen Asset Management which has over $500 billion in assets under management says “it’s difficult really to see a lot of value in the bond markets.”
It’s no surprise that intelligent investors are reconsidering the meaning of ‘safe haven assets’. They are diversifying into true safe haven assets; hard value commodities such as gold. Stocks and bonds may go to zero, but gold never will.
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