Over the past 10+ years of unprecedented central bank liquidity creation, traditional thinking about monetary policy, financial markets, and government intervention in those markets has been turned on its head. Thanks to trillions of dollars of liquidity injected into economies around the world, asset prices remain extraordinarily elevated and interest rates remain unprecedentedly low. That has helped fuel an orgy of debt issuance that threatens governments, corporations, and investors.
The latest sign that traditional financial thinking has gone by the boards is the fact that over a dozen junk bonds now have negative yields. Yes, that’s right, companies whose credit ratings are considered junk are actually able to get investors to pay them in order to take their debt. That’s absolutely mind-boggling.
Traditionally junk bonds have been high-yielding bonds, as the risk of purchasing the debt of a non-creditworthy borrower is higher than, say, government bonds or other bonds considered just as safe. Just as normal corporate bonds offer a higher interest rate than government bonds, junk bonds offered a higher interest rate than normal corporate bonds. But over a dozen companies in the EU now offer their junk bonds at negative rates, so screwed up has the European economy become as the result of the European Central Bank’s (ECB) negative interest rate policy.
That policy shows no signs of abating, either, now that IMF chief Christine Lagarde has been tapped to succeed the dovish Mario Draghi as the ECB’s new head. The ECB will continue its quest to maintain negative interest rates, despite the fact that all they have done is spur debt issuance by corporations without any notable improvement in their business performance.
As long as central banks continue to fail to learn the lessons of their past mistakes, expect more and more junk bonds that should be netting investors high yields to earn them negative yields instead. Of course this can’t last forever, but as the old saying goes, markets can stay irrational longer than investors can stay solvent. But when this circus finally ends, it won’t be pretty.