The sub-zero club has welcomed its newest member: Greece

By 5 minute read

Only ten years ago Greece found itself at the epicenter of the European debt crisis. Now, the country has completed a spectacular comeback by issuing bonds at a negative yield.

Negative yielding debt – which long was deemed impossible – is a practical reality for investors all over the world. The pile of debt trading at negative yielding debt has grown to over 12tn USD, and the list of countries and companies being paid to borrow is growing. Now the "sub-zero club" has welcomed a remarkable new member: Greece. In October, the Greek government raised about 500 million from its auction of 13-week bills at a yield just below zero percent. The milestone caps Greece's extraordinary rehabilitation in the eyes of investors, and is a telling example of the widespread effects of the global search for yield.

Eurozone debt crisis

Greece has managed to exit its sovereign debt crisis , at least that's what the capital market is showing. Only years ago, Greece found itself at the epicentre of the Eurozone debt crisis. In 2009, Greece's budget deficit exceeded 15 percent of GDP and there was a serious risk that the country would default on its liabilities. The EU and the IMF provided an emergency package to fund the Greek government during this crisis. The IMF, EU and the ECB - also known as the Troika - imposed harsh austerity measures on the Greek economy. However, debt levels were unsustainable even with effective economic reforms. It became quickly apparent the austerity measures led to an unprecedented contraction of the economy. By 2012 the Greek economy had shrunk by over 20% from the 2008 level, and bond yields surged to crisis levels above 35%. In 2012 private bondholders agreed to a restructuring negotiated by the Troika, which reduced the value of their bonds to with more than 75%. By this time a large proportion of Greece's sovereign debt was owned by the IMF and the EU, which did not take an explicit haircut on the nominal value. Instead maturities were extended far into the future and interest payments were cut. This effectively further reduced the present value of Greece's debt load. This bailout of Greece was the biggest financial rescue of a bankrupt country in history.

Source: Aegon Asset Management, Bloomberg

Greece still has a debt to GDP ratio of 180%. However, 80% of that debt is in the form of loans from the EU and IMF. These loans have extremely long maturities and low interest payments. As a result, the rollover risk and interest cost are very manageable in the next couple of years. Investors owning Greek government bonds, rightly argue that the risk of a near term defaults is therefore very low.

The sub-zero club

The current situation for Greek sovereign bonds could not be more different from a decade ago. Then, investors in Greek debt faced sizeable negative returns due to the quickly deteriorating creditworthiness. Now, investors are happy to lock in negative returns on Greek government debt, implying that investors are effectively paying the country for the privilege of lending it money for a short period. This makes Greece the latest country that has issued debt at negative yields. The club has become less exclusive in the past years. Since 2009 when Sweden became the first major economy to experiment with sub-zero rates, multiple central banks have broken the zero bound, dragging more and more debt into the negative territory. In fact, the pile of debt trading at negative yielding debt reached a record of 17tn USD by August, and is currently approximately 12tn USD.

That first sub-zero issuance of Greece is just one telling example of the remarkable situation in the global bonds markets. In August, Germany sold 30-year bonds with a negative yield for the first time, a milestone for a fixed-income market as all German government bonds were trading at yields below zero. Also, the club is not exclusive to sovereigns, as investment-grade and even a few high yield bonds have reached the sub-zero territory. All examples how the extraordinarily low central bank rates are being priced into all fixed income markets.

The Greek comeback is remarkable, but does not stand on its own. All former PIIGS – once an acronym to classify the struggling Eurozone economies – can now borrow at negative rates and have seen a major decline of the interest rates paid on their sovereign debt. Irish debt up to 10 years is traded at negative yields, whilst Portuguese and Spanish bonds with maturities between 5 and 10 years have traded below zero. Still, these bonds offer a positive spread over the safest eurozone bonds that trade even deeper in the negative territory.

Source: Aegon Asset Management, Bloomberg

The sub-zero club: Not only a eurozone phenomenon

The sub-zero club is not exclusive to eurozone countries. The low inflation rate dynamics made central banks all over the world deploy unconventional policies. Besides the ECB, the central banks of Japan, Sweden, Switzerland, and Denmark have all set sub-zero policy rates, in many cases enhanced with asset buying programmes. Also, euro-denominated bonds of emerging markets such as Poland, the Czech Republic and Hungary trade at sub-zero yields too. Across the pond – with positive policy rates set by the Federal Reserve - US companies benefit from the low yield environment in Europe. In August, when yields hit their lows, 45% of the EUR investment grade benchmark traded at negative yields and 8% of the total benchmark was comprised by EUR-denominated bonds issued by US firms, such as Apple and IBM.

Source: Aegon Asset Management, Bloomberg

Escaping from negative territory

For several decades global yields have been falling, as growth decelerated and inflation declined. More recently, the pressure on yields has intensified, driven by extreme and unconventional monetary policy in large parts of the world. While central banks around the world are in easing mode and the ECB continues their asset buying program, it is likely that the negative yields remain a reality for the near future. Some central banks are looking to move away from negative rates, such as the Swedish central bank, but overall the bias for most central banks is still to cut rates. With interest rates at record low levels, we foresee relatively low expected returns for most traditional low-risk fixed income categories in the coming period.

Jordy Hermanns

About Jordy Hermanns

Investment Strategist