Financing a company’s debt and then having to pay for the privilege: it sounds absurd, but it has been a reality in Switzerland for some time already…
You can barely believe it’s true, and yet it really is. If you were to buy a bond of Swiss pharma giant Roche and hold it until it expires in 2022, then you will face a ‘guaranteed’ loss of 0.08%. In other words, you have to pay for the ‘right’ to entrust your money to a company for six years… By the way, I put the word guaranteed between quotation marks for a good reason: that guarantee is based on the assumption that the company doesn’t go bankrupt in the meantime. Not that that’s very likely – the company has an AA credit rating, which is impressive for a company – but you never know these days.
The graph on the right shows the situation in Switzerland right now. On the vertical axis, the return, and on the horizontal axis, the term of the bond. The points indicate specific bonds on the Swiss market. So each point is a specific bond of a different company or local government. Specifically, bonds with a certain credit rating (AA) are included that are not active in the financial sector. What the graph shows is that you have to pay to invest in a bond with a maturity up to seven years. Only bonds with longer maturities will ‘earn’ you money, but even that’s not much. On the left we see, for sake of comparison, the graph for corporate bonds in the Eurozone. You can see there at least a small return, though there too it’s pitiful.
It just seems crazy. So why do people join in this madhouse? Simple: it’s all a game of relatives. If you invest in Swiss government bonds, your returns will be even worse. Swiss 2-year rates for instance are currently below -1.0%, while a Swiss government bond with a maturity of seven years will cost you 0.6% a year on average. Keeping that in mind, a Swiss corporate bond may well be worth investing in after all… Especially if you’re a pension fund that is not allowed to invest in equities, so it’s very much a relative choice.
But this is nothing new: over the last 12 months, Swiss capital market rates (10-year rates) have spent most of the time in negative territory. So the idea that you have to pay to invest your money in bonds is no longer a big deal there.
And yet something special has happened in recent weeks, though not in Switzerland but on the other side of the world, in Japan. At the end of January, the Bank of Japan unexpectedly lowered its policy rate even further, so Japan has now joined the negative policy rates club, too. This decision has resulted in Japanese capital market rates falling by a quarter of a percent over the last two weeks. And last Tuesday was finally the moment when Japanese capital market rates fell below zero.
So it may be nothing new, but there is an important difference between the Swiss and Japanese markets: the size of their bond market. Whereas the Swiss economy is relatively small in European terms and doesn’t amount to much on a global scale, Japan is still the world’s third largest economy. Add to that the Japanese government debt of 240% of GDP, and you’ll see straight away that the Japanese bond market counts big time on a global scale relative to Switzerland’s contribution.
The size of the Japanese bond market is clearly indicated in the next graph. This shows the historical development of the amount of outstanding debt with negative rates. According to calculations by JPMorgan, government debt now stands at USD 6 trillion on which investors have to accept a negative return for the privilege of investing in…
It all seems so unreal if you think about it: it’s the country with just about the largest government debt in the industrialized world, and yet you have to pay to invest in it’s bonds…