Ladies and gentlemen, some extraordinary interest rate levels have been achieved this month.
The yield on 10-year Spanish government bonds collapsed to 2.54%. The French 10-year yield hit a shockingly low 1.66%.
These are the lowest rates for both countries in recorded history.
Italy’s 10-year yields, which recently sunk to 2.69%, were only lower during a brief period near the end of World War II.
And as you can see in the following chart, the decline in yields has been even more dramatic for other nations…
Greek government bond yields, for example, have fallen all the way down to sub-6% after they were briefly yielding over 30% (literally off the chart) during the height of the Greek debt crisis.
Overall, European yields have been driven lower by stagnating eurozone economic growth, disinflation (declining inflation) and rising geopolitical tensions.
But the biggest influence on yields has been the market’s faith in the European Central Bank (ECB) and its chief, Mario Draghi.
Since Draghi’s “whatever it takes to preserve the euro” speech at the apex of the European debt crisis, peripheral European yields have declined significantly.
But last week, in what appears to be a belated attempt to deliver on Draghi’s promise, the ECB announced a series of measures aimed at stimulating eurozone economies and increasing bank lending.
The main policy rate was cut from 0.25% to 0.15%, and the marginal lending facility rate was reduced, as well. But the big move was an unprecedented step towards negative interest rate policy.
The ECB cut its deposit rate for banks to -0.1% from 0.0%. Banks will now have to pay for excess reserves parked at the ECB. This doesn’t directly affect savings accounts held at these banks, although it does indicate that the war on savers continues.
When asked why the ECB didn’t go all-in and announce quantitative easing, Draghi commented, “Are we finished? The answer is no, we aren’t finished here.”
So, the fate of Europe is sealed. The eurozone is going the way of Japan… stimulus and stagnation for decades while the debt overhangs remain unresolved and grow even larger.
The Search for Yield
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Of course, persistently low interest rates encourage a reach for yield as investors shift towards riskier investments. There is perhaps no better example of this yield grab than the high-yield debt market.
The following chart shows benchmark indices for U.S. and European high-yield bonds:
In the United States, benchmark yields for speculative-grade credit issuers are near the all-time lows set in April 2013, and their European counterparts are at an astoundingly low 3.5%.
Yes, default rates are low. But financial markets are interconnected. Easy monetary policy and slowing global economic growth are creating a worldwide phenomenon.
According to BlackRock, 81% of the entire global fixed income universe currently yields below 4%.
That means most issuers – except for companies and governments with the most putrid credit qualities – are now able to borrow below 4%.
The Great Yield Compression is creating a treacherous environment for investors, especially those in retirement or approaching retirement.
If you’re struggling to find worthwhile income investments, check out my article on closed-end funds from February. All three funds have done well since my mention, yet they’re still trading at decent discounts to their net asset values – and all still yield above 7%.
The Great Yield Compression has also served to pump up the value of many low-growth dividend stocks, which have become expensive as a result.
This market seems to endlessly reward excessive risk taking. But in the end, those that haven’t reached for yield will find that they have created lasting wealth through astute investment decisions.
Safe (and high-yield) investing,
Alan Gula, CFA