The flight to safety on global markets is turning into a stampede, as skittish investors pour so much money into safe government bonds that yields in many countries have plunged to the lowest levels seen to date.
On Wednesday, the mania for bonds swept up countries as diverse as Germany, the United States, Britain, Canada and Switzerland. Yields on bellwether U.S. 10-year Treasuries sank to 1.62 per cent in late trading, while comparable German bonds, known as bunds, sagged to 1.27 per cent. Both are record lows. Canada and Britain also benefited, with their key government bond yields falling to 1.79 per cent and 1.64 per cent, respectively.
Switzerland is in a class by itself, with its bond yields dropping to a mere 0.54 per cent, indicating that investors are asking for almost no return for lending the government money over the next decade.
The low yields are a sign that investors are so nervous about the safety of their capital that they're willing to accept yields close to zero in instruments considered low risk. "The prime consideration is not losing your shirt," says Martin Barnes, chief economist at BCA Research, a Montreal-based independent research firm.
The yield drops on Wednesday were triggered by jitters over the future of the euro zone and worries about the health of Spanish banks. But triple-digit declines on North American stock markets and signs of flagging global economic growth also did their part to stoke the mania for bonds.
With so much to worry about, investors pulled cash from risky assets and parked it in bonds of countries perceived as havens, bidding up their prices in the process. Because bond prices and yields move inversely to each other, the buying mania had the result of causing yields to plunge.
"The key reason is because of what's happening in Europe," said David Madani, an economist at Capital Economics. "Markets are reacting to the potential Greek exit [from the euro] but more importantly, what that might mean for sovereign debt and banking more in general in Europe."
Mr. Madani said investors are beset by "so much uncertainty … You don't know what problems lurk around the corner."
For investors who've been playing the bond market in the haven countries, the rising prices have been a lucrative boon. Prices rose by about $10 for each $1,000 face amount of bonds Wednesday, while yields fell about 10 basis points, or 1/100th of a percentage point. By the standards of the fixed-income market, the changes are considered major single-day fluctuations.
Meanwhile, the bond markets of weaker countries, notably Italy and Spain, sold off as worried investors dumped government bonds, driving their yields sharply higher.
Many players have been surprised at just how low yields have fallen in the countries regarded as having better credit ratings. "It's just extraordinary," commented Mr. Barnes.
Before the financial panic in 2008-09, it was commonly assumed that longer term interest rates had a natural level around a country's economic growth rate, plus its inflation rate. For Canada and the U.S., that would imply normal rates would be about 4 per cent, or more than double their current levels.
Mr. Barnes says that, while yields have fallen lately because of risk aversion in Europe, interest rates have been on a gradual, lower trajectory for years, driven by widespread worries about the safety of money in the stock market, loose monetary policy by central banks and a decline in the demand for credit in the private sector.
Now the big question is just how low rates can go, and whether there are factors that might eventually cause rates to move back up.
Japan and Switzerland offer clues on the downside potential for rates because both countries have yields on longer term government bonds of less than 1 per cent. Other haven countries are now not far off that level.
"In theory, [yields]can go down to 1 per cent or lower if we get continued negative sentiment or shocks," Mr. Barnes says.
One of the perplexing aspects of recent bond price movements is that money has flooded into the United States, even though it has huge federal government deficits, like the ones that are making investors nervous about European countries. Mr. Barnes predicted that if U.S. politicians don't eventually tackle their own deficit problems the markets could "turn on them viciously and we will see American bond yields spike a lot higher."
10-year bond yields (May 30, 2012)
Bond yields have plunged near record lows in countries perceived as havens while remaining at nosebleed levels in riskier nations...
Germany 1.27 per cent
Switzerland 0.54 per cent
Japan 0.84 per cent
U.S. 1.63 per cent
Canada 1.79 per cent
Greece 28.32 per cent
Spain 6.61 per cent
Ireland 7.08 per cent
Portugal 11.35 per cent
Hungary 8.56 per cent