“Bond king” Bill Gross did not mince words Thursday when he called out a problem in the credit markets that could have catastrophic consequences.
In a tweet though his firm, Janus Capital (JNS), Gross asserted that the spread of negative interest rate policy though central banks around the world will cause the record-breaking $10.4 trillion of negative-interest-rate sovereign bonds on the market to “explode one day.”
Gross has often noted that negative interest rates could lead to a credit bubble with massive damages to bondholders. Here’s at least part of the reason why:
Negative interest rates have been adopted by stunted economies in Japan and parts of the eurozone in a bid to promote spending where more conventional policies have failed. The policy effectively causes bondholders to pay the issuer if they hold it to maturity. But demand for the bonds is still growing. That’s because there are positives to buying bonds with negative interest rates—they generally promise lower risk. Banks in the euro currency bloc are also piling in as a result of higher capital requirements. And since yields have an inverse relationship to price, demand has helped push down yields.
“Unconventional monetary policies, regulatory risk mitigation by banks, and a flight to safety in global financial markets have all contributed to the ongoing rise in the amount of sovereign debt trading with a negative yield,” head of macro credit at Fitch, Robert Grossman, wrote in a note earlier this month.
While some investors are trudging through lower yields, others investors have been driven to riskier and/or higher yielding areas—such as U.S. treasuries and longer maturity bonds. But should yields rise, investors holding such bonds could also face massive losses.
Goldman Sachs released a note to clients earlier this month, estimating if U.S. interest rates rise by 1% (noting that the rate is currently 0.25%), bondholders could lose $1 trillion as the value of the underlying bond falls and yields rise, hitting securities with longer maturities the hardest. That exceeds the losses from mortgage-backed bonds during the financial crisis.
Gross, who runs the $1.4 billion Janus Global Unconstrained Bond Fund, is not the only major investor to decry negative interest rates. DoubleLine’s Jeff Gundlach called the policy “the stupidest idea I have ever experienced,” Reuters reported, while BlackRock’s Larry Fink wrote in his most recent letter to investors: “Not nearly enough attention has been paid to the toll these low rates—and now negative rates—are taking on the ability of investors to save and plan for the future.”