It was a nasty end to the week for the financial markets, with a sell-off in equities and cash heading into the government bond market. The worries were twofold – the familiar concerns about the rate of world economic growth, and the more pressing issue of the Brexit vote and what on earth happens if Britain leaves the EU. Nobody quite knows the answer.
The influential German finance minister, Wolfgang Schäuble, warned his colleagues yesterday that if Britain voted to leave it could not be a case of “business as usual” – adding entertainingly that the only people likely to seek closer integration in this case would be Luxembourg.
It is something of a cliché to say markets hate uncertainty – but nonetheless true. And so equities took a bit of a pasting again yesterday, with banks taking the brunt of the battering. And cash – yet again – flooded into government bonds. Nobody now thinks Janet Yellen will push for a Fed rate increase next week.
Yesterday the focus was on German government bonds, the European benchmark, where 10-year interest rates fell to a low of 0.01 per cent. Tens of billions of shorter dated EU government debt now trades at negative interest rates, supported by massive ECB bond-buying.
If this sounds crazy, it is because it is. But the peculiar logic of the market has kept the bond bubble inflating ever further. Investors are nervous of equities and many are seeking a safe haven. Worries continue about the outlook for growth and inflation. Ireland has benefited, with ten-year yields now camped well down from 1 per cent. If Brexit is avoided, the NTMA should be able to raise money at super low rates later this year.
But, when you stand back from it, is this bond market really sustainable? Bill Gross, the founder of Pimco, the massive investment fund, said this week that some €10,000 billion of bonds were now trading at negative interest rates. This, he said in a tweet, "is a supernova that will explode one day". The question, of course, is when. Gross did not speculate on this, but if we have learned anything from recent economic history it is that bubbles, sooner or later, do burst.
