24 June 2022
The end of the NIRP experiment
Rising inflation around the world could spell the end for negative interest rate policies – except in Japan.
Fundamentals
In an effort to stimulate economies and push up inflation in the aftermath of the 2008-2009 financial crisis, central banks adopted increasingly unorthodox measures, most notably the negative interest rate policy (NIRP). Over a decade later, high and rising global inflation pressures could spell the end of the NIRP experiment. Last week, the Swiss National Bank (SNB), an early adopter of NIRP, opted to raise rates by 50 basis points (bps), its first hike in over 15 years, while the European Central Bank (ECB), another NIRP proponent, signalled that rate hikes are now on the table at its July and September meetings. In both instances policymakers noted that the falling domestic currency was effectively “importing” pricing pressure from overseas, further de-anchoring inflation expectations and highlighting the need for tighter policy. The Bank of Japan (BoJ) remains an outlier, doggedly holding rates in negative territory and vowing to defend its Yield Curve Control (YCC) program, which effectively caps the yield on the 10-year Japanese government bond at 0.25%. However, mounting investor pressure forced the BoJ to spend a record JPY 10.9 trillion (USD 80.7 billion) last week to defend the YCC policy, a weekly figure that dwarfs the ECB’s monthly target of EUR 30 billion in asset purchases. With the BoJ digging its heels in, the yen is now trading at its lowest level vs. the US dollar since October 1998. (All data as of 22 June 2022.)
The Bank of Japan was forced to spend a record amount to defend its YCC program
Source: Bloomberg, J.P. Morgan Asset Management. Data as of 22 June 2022.
Quantitative valuations
NIRP has effectively acted as a heavy anchor weighing down bond yields globally and suppressing fixed income volatility. However, tighter monetary policy and higher inflation have swiftly melted the stock of negative yielding debt, falling from over USD 11 trillion at the start of 2022 to just USD 1.6 trillion as of 22 June 2022. The sell-off in core bonds has had knock-on effects on higher yielding parts of the fixed income market. Emerging market valuations, particularly in high yield, are trading well above historic averages, offering investors plenty of cushion against further volatility. While short-term flows can be driven more by fear than by valuations, higher bond yields across the board are offering long-term investors attractive entry points into bond markets.
Technicals
As central bank policy enters this transition period, volatility in financial markets is likely to remain elevated. In the six trading days surrounding the week of the Federal Reserve (Fed)’s 15 June 2022 meeting, the two-year yield moved more than 5 bps each day and, on average, moved 17 bps daily as investors attempted to digest the Fed’s announcement. Meanwhile, central banks’ actions are also having a significant impact on currency markets. Last week, the euro’s intra-day trading range hit its highest level since March 2020 as the market attempted to digest the latest forward guidance (or lack thereof) from the ECB. Despite the grind higher in bond yields, investors continue to remain on the sidelines. Positioning surveys continue to suggest that investors remain underweight duration and that fixed income outflows have continued. For example, US investment grade has now experienced 12 consecutive weeks of outflows, with year-to-date net outflows exceeding USD 64 billion. While there have been some tentative signs that investors are beginning to trim their duration underweights, the heightened market volatility and the murky economic outlook have resulted in continued cautious positioning.
What does this mean for fixed income investors?
As central banks continue to adjust to a new inflation regime, volatility is likely to remain elevated. Until inflation figures begin to stabilise investors should consider staying underweight duration within their portfolios and only lightly utilise their risk budgets. The outlook within fixed income markets is evolving rapidly, with the dominant narrative fluctuating in a matter of hours. In these fast-moving markets investors should be mindful of the benefits of active management in helping reposition portfolios rapidly in response to a changing economic landscape.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors
include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations
is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors
are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum