Draghi’s Negative-Yield Vortex Draws in Corporate Bonds

by Alastair MarshSally Bakewell

(Bloomberg) -- Credit markets are being so distorted by the European Central Bank’s record stimulus that investors are poised to pay for the privilege of parking their cash with Nestle SA.
The Swiss chocolate maker’s securities, which have the third-highest credit ranking at Aa2, may be among the first corporate bonds to trade with a negative yield, according to Bank of America Corp.’s London-based strategist Barnaby Martin. Covered bonds, which are bank securities backed by loans, started trading with yields below zero at the end of September.
With the growing threat of falling prices menacing the euro-area’s fragile economy, some investors are calculating it’s worth owning Nestle bonds, even with little or no return. That’s because yields on more than $2 trillion of the developed world’s sovereign debt, including German bunds, have turned negative and the ECB charges 0.2 percent interest for cash deposits.

“In the same way that bunds went negative, there’s
nothing, in theory, to stop short-dated corporate bond yields going slightly negative as well,” Martin said. “If investors want to park some cash, the problem with putting it in a bank or money market fund is potential negative returns, because of the negative deposit rate policy of the ECB.”

Market Driven

Vevey-based Nestle SA’s 0.75 percent notes due October 2016 were quoted to yield 0.05 percent today, according to data compiled by Bloomberg. Officials at Nestle declined to comment on its bonds before publication of the company’s full-year 2014 results on Feb. 19
It isn’t the only company with short-dated bond yields verging on turning negative. Roche Holding AG, the world’s largest seller of cancer drugs, issued 2.75 billion euros of bonds with a coupon of 5.625 percent in 2009. The notes, which mature in March 2016, pay 0.09 percent, Bloomberg data show.
“The current yield is market-driven,” Nicolas Dunant, head of media relations at Basel, Switzerland-based Roche, said in an e-mail. “The bond has traded up because it has become increasingly attractive for investors in the current low-rate environment.”
The average yield investors demand to hold investment-grade corporate bonds in euros fell to a record 0.9868 percent yesterday, less than half the 2.1 percent level at the end of 2013, according to Bank of America Merrill Lynch index data.

Zero Coupon

Borrowers have yet to test negative rates in the new issue market. Instead of having a negative coupon, borrowers could opt for a zero-coupon bond with a price above par, according to Frank Will, head of covered bond research at HSBC Holdings Plc in Dusseldorf.
“If you hold a bond to maturity and it has a negative yield that means you will get back less than the price you paid for it,” said Mahesh Bhimalingam, head of European credit strategy at BNP Paribas SA in London. “However, if it goes more negative you could benefit from gains in the price.”
Falling prices and stubbornly high unemployment encouraged ECB President Mario Draghi to embark on an unprecedented plan to buy 60 billion euros of assets a month for at least 19 months. The euro area’s annual inflation rate fell to minus 0.6 percent last month, matching the biggest decline in prices in the history of the single currency, according to data published by Eurostat.

‘Fantastically’ Overpriced

The stimulus program has encouraged traders to take massive concentrated positions in “fantastically” overpriced markets, according to Paul Singer, the billionaire founder of Elliott Management Corp.
“Today’s trading levels of stocks and bonds reflect ‘thumb on the scale’ valuations driven by persistent and massive government asset purchases and zero percent (or lower!) short-term policy rates, as well as an essentially unlimited tolerance for risk,” Elliott wrote in the firm’s fourth-quarter letter dated Jan. 30, a copy of which was obtained by Bloomberg News.
The ECB started buying covered bonds in October and has since accumulated 40.3 billion euros of the notes, which typically have higher credit ratings because they’re backed by assets as well as being guaranteed by the issuer.
Deutsche Bank AG’s 3.375 percent covered notes maturing in 2018, which are backed by home loans, last week yielded minus 0.03 percent, according to data compiled by Bloomberg.
“It could be a choice between buying bonds with slightly negative yields, where at least you have the potential for prices going up further, or leaving your cash on deposit with little potential upside,” said Joseph Faith, a credit strategist at Citigroup Inc. in London.