How Low Can Yields Go?

Now that the EuroZone quantitative easing program is underway, MoneyShow's Jim Jubak wonders how low yields can really go without causing new problems.

How low can they go? That's what we really want to know. Now that the European Central Bank as announced its plan for buying $60 billion euros worth of assets every month, what we're seeing is interest rates that were negative for the better credits in Europe, such as the German bund, are getting more negative so that, right now, well, on March 10 to pick a date, everything in Germany that had a maturity of seven years or less, so like the two year and the seven year, were all paying negative rates.

The theory of why do you want to buy a negative bond, well, paying a negative yield, which means you're paying for the privilege of lending your money to somebody, well the idea is that with the European Central Bank buying more bonds and there not being a whole lot of issuance in the market that we're going to see these yields move from say a -0.16 to a -.18 or something like that so what we're looking to see is how low these are going to go.

The reason for this is not simply a parlor game but because there's real damage that is done in the European financial system from low rates. If you look at the kind of rates, there are companies with fixed obligations to pay out yields, like insurance companies. For them, negative rates are a real problem, especially if there's not a whole lot of stuff to buy out there, new issuance, so that insurance companies looking at really sort of losing money as they try to meet their premium needs and to invest their money, pension funds having the same problem, so these are real issues.

The more negative rates get, the more pressure this puts on certain parts of the European financial system. I understand the European Central Bank is trying to get inflation and growth up but there's tension here. It can't go on forever because these are real problems that are out there and the question is, if you want to track this, look to see how far out on the yield curve negative yields go. If we start to see negative yields on the 10-year German bond, I think we're really sort of heading toward not the old crisis but a different kind of crisis.