In theory, fixed income is supposed to give investors an easy way to get decent yields without putting their principal at too much risk. But now that logic doesn’t apply when many governments, institutions, and even some corporations are literally being paid to borrow because of negative yields. And what was unthinking a few years ago now makes up $1.5 trillion in dollar-equivalent debt trades according to Morgan Stanley analyst Andrew Sheets.

“The last 250 years have seen depression, war, pandemics, deflation, inflation and a host of other ills. These have never justified negative yields for a meaningful amount of time. Maybe this time is different – the difference being that you now need to justify current pricing,” he writes.

US UK historical yields Negative Yields

Yields haven’t been negative for a sustained period in at least 250 years

Sheets says that the justifications being thrown around (lack of inflationary pressure, an aging population, or an extreme need for certainty over yields) aren’t persuasive, but that doesn’t change the fact that fixed income investors have to make the most of the situation nonetheless. He recommends moving out along the risk curve, but also warns that “an old adage about pennies and steamrollers comes to mind.” It’s not that Sheets isn’t aware of the risks, but he expects accommodative monetary policy to last at least through the end of this year and doesn’t see that investors have better options.

central bank policy rates Negative Yields

US rates are higher than on German or Japanese bonds, but Sheets recommends looking to emerging market bonds as well. He gives the example of Hungary as a country that will benefit from an economic recovery in the eurozone without its own bond yields being affected by quantitative easing.

These effects should also be good for equities as companies buy back short-term debt, buy back shares, and shift short-term debt to long-term to better take advantage of the ultra-low rates available.

all assets return v skew Negative Yields

Negative yields: USD still has support, says Sheets

One thing that nearly every analyst seems to agree on is that the dollar is going to continue getting stronger because of the divergence of central bank policies – Sheet’s puts it at 1.05 EUR/USD by the end of the year, suggesting that we are already near the floor (currently 1.058). Crowded trades are always a reason to worry. Sheets acknowledges this but says that there is enough ‘fundamental and valuation support’ that a stronger dollar should be a good bet anyways.

Yield differentials and USD strength Negative Yields