Saturday, April 25, 2015

Negative Yields On Swiss Debt

Earlier this month, Switzerland became the first country to ever issue 10-year sovereign debt at a negative yield. Interest rates are so low and demand so high for bonds in Europe that approximately one-third of Euro zone debt now carries negative yields.

This presents some obvious problems and some not so obvious problems. First, pension money that is accustomed to positive, albeit low, yields on fixed rate instruments is now searching outside of Europe for bonds, hence the demand for bonds in the US and the subsequent low interest rates we are seeing. Normally, with the US economy heating up, unemployment falling, and the Fed exiting Quantitative Easing, we'd see rates begin to rise. With European rates as low as they are, there is a mad dash for other sovereign debt, including that of the US.

One not so obvious problem has been negative mortgage rates for many homeowners in Europe. Like the US, many countries in Europe issue floating rate mortgages. However, the Europeans didn't put a floor, a minimum, interest rate in many of the mortgages they wrote. When Euribor fell into negative territory, Euribor-based adjustable rate mortgages did the same. The banks, as one might expect, are loathe to send money to an individual who took out a mortgage with the bank, yet that is exactly what must occur when mortgage rates become negative. As of right now, the issue is getting sorted out in court.

What does this mean for retirees looking for retirement income? As long as higher bond demand is present, yields will remain low unless we get Fed intervention (perhaps 2016). Choose your investment managers wisely, double check their bond experience, and don't get caught too far out on the maturity curve, lest you get hurt when rates finally do rise.