Bill Jamieson: Something bigger than Brexit is hitting markets

Last week saw a historic event in our financial market. The cost of UK government ten-year ­borrowing fell to just 1.2 per cent '” its ­lowest level ever.

A low yield is signalling a marked rise in ­investor apprehension about the economic and financial outlook. Picture: Getty Images/iStockphoto
A low yield is signalling a marked rise in ­investor apprehension about the economic and financial outlook. Picture: Getty Images/iStockphoto

Such an ultra-low yield would, in ­theory, signal a markedly optimistic period for investors, the government and the ­economy generally.

But that’s hardly the case now. Such a low yield is signalling a marked rise in ­investor apprehension about the economic and financial outlook.

Government stock is seen as the safest form of investment — the shelter when other assets such as equities, currencies or property are looking less secure.

The fall in the yield of government gilt–edged stock is the mirror image of a rise in its price, reflecting in turn powerful investor demand to hold government debt.

So what is it that is driving investors to pile into stock that is yielding less than it has ever done in its ­history?

The immediate explanation – and the one certainly closest to hand – is growing uncertainty over the EU referendum. ­Headlines have been ­dominated by ­warnings of recession, a weakening pound, rising unemployment and falling house prices should we vote to leave.

It was not only gilt-edged stock which reflected investor concerns. The FTSE 100 Index fell 121 points, or 2 per cent on Friday to 6,110, with almost every single stock in the red amid investor jitters over the vote. Investor fears also hit the pound, which fell 0.9 per cent against the dollar to $1.433.

While referendum uncertainty is ­definitely a factor, it is by no means the only one and arguably not the most important. For if it was, why then have the returns on German government debt also hit all-time lows? The yield on German ten-year bunds sank close to a zero yield on Friday to 0.02 per cent.

Global equity markets were also hit. The French CAC 40 index fell 2.2 per cent, the German DAX 30 retreated by 2.4 per cent, Italy’s FTSE MIB tumbled 3.5 per cent and Spain’s Ibex index lost 3.5 per cent. While US markets were sheltered from the worst of the losses, the Dow Jones Index dropped 119 points or 0.7 per cent.

Finally the gold price, that universal fear gauge, rose to $1,275 an ounce, up 0.9 per cent on Friday — a near three-week high and on track for a second straight weekly rise. Back in January the price was ­languishing at $1,050 an ounce.

Markets are reflecting bigger concerns – and these are mainly centred on worries about the global economic outlook. Slower growth usually leads to cuts in interest rates to stimulate flagging performance.

But the problem here is that a growing number of government bonds are already yielding less than zero: for Switzerland and Japan the yield is negative for ten-year ­borrowing. Investors are suffering a ­penalty for holding them — though they may judge that penalty to be less than what they would incur by holding other assets.

What these ultra-low government bond yields signify is a growing apprehension that the world may be heading for another financial crisis. This time government and company debt may not provide any ­shelter.

For the past seven years, in the wake of the financial crisis, governments have been able to borrow cheaply. Now, far from the cost of borrowing recovering to more normal levels, the cost has got cheaper still.

The pile of debt with a negative yield is growing rapidly. The credit rating agency Fitch estimates it has exceeded $10 trillion, with Japan the largest source.

Why need investors worry if the price of ­government stock has been rising? The ­mirror image of that strength is low and negative yields. That is a big worry for banks, insurance companies and public agencies who operate pension funds, and all those who save through pension schemes.

Pension funds are the biggest holders of government stock. But the lower the yield, the more difficult it is for pension funds to generate returns to meet the expectations of pension fund savers. It is the main reason why many pension funds today now have deficits.

Professional investor Bill Gross, the widely followed founder of Pimco who now works for Janus, has talked of a “supernova” bust.

Goldman Sachs recently warned that an unexpected upward move in interest rates of one percentage point would generate losses of $1 trillion for bondholders. A separate note from Goldman warned of a significant possibility of such a development in interest rates in the second half of this year.

What we need is sustained global growth. But there is little sign of that at present.