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Fear effect in Europe sees MNCs paid to borrow money
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GERMANY and France have been able to borrow at negative rates for some time, meaning investors are paying to lend them money, but with interest rates falling further as the European Central Bank gears up to launch quantitative easing, multinationals are also now getting paid to borrow.
The phenomenon is a result of investors seeking a safe place to park their money in debt markets where interest rates have been dragged down to ultra-low levels.
The need for low-risk instruments, and with little concern about inflation, has seen investors actually push the interest rate into negative territory for short-term German and French government bonds.
Swiss food giant Nestle was the first to see the interest rates on its euro-denominated debt fall into negative territory when the yields on bonds that expire in nearly two years fell below zero.
“It is sort of a domino effect. If sovereign bonds are paying less, then this ricochets and those of corporations will pay less and finally investors will enter uncharted territory,” said Christophe Quesnel, a trader at Oddo Securities, a corporate debt specialist.
“Among the distortions caused by low interest rates and QE is that some governments, corporates and households are now getting paid to increase debt,” said analysts at Royal Bank of Scotland.
“For the first time, high-rated corporate bonds are also trading at negative yields (Nestle), and many are near-zero (Shell, Novartis, Air Liquide, BASF, Sanofi, etc),” added RBS.
The ECB has brought its main interest rate to just 0.5 percent as it seeks to boost growth in the eurozone by lowering borrowing costs.
With the eurozone now hit by a bout of deflation thanks to falling oil prices, the ECB is about to launch quantitative easing in which it will buy up 60 billion euros (US$68 billion) of sovereign and corporate bonds per month.
This will push down yields, or the rate of return to investors, even further.
Fear effect
But why would investors accept paying to loan money to someone?
“It’s the effect of fear” about the delicate situation in Europe, said Juan Valencia, a credit specialist at Societe Generale CIB.
“Investors are putting their money in the safest instruments, as they aren’t sure about getting their money back with other investments. Thus they are paying for the ‘privilege’ to loan to the most solid states and corporations,” he said.
The ECB’s QE program, which will buy up over a trillion euros in bonds, will have a massive impact on the euro-denominated debt market which totals just 1.5 trillion euros.
Valencia said 900 billion euros of that debt already yields under 1 percent, and 400 billion less than 0.5 percent.
Some investors, such as pension funds and insurance firms, are required to place a certain percentage of their funds into bonds issued by countries and companies with secure credit ratings.
With the ECB entering the market, finding good returns in safe investments will get even harder.
“There is a compression process underway and everything is heading for zero,” said Valencia.
“Investors are thus being pushed to choose bonds of companies a little less safe or frankly to change assets to get a better return,” said Quesnel.
For companies “it is excellent news,” said Valencia, but “just because money is practically free doesn’t mean some companies won’t find themselves in complicated situations.”
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