Yields on benchmark German government bonds are within touching distance of zero for the first time in almost three years as Europe's economic performance stalls and concerns over global trade spur investors toward havens.
A no-deal Brexit, upheaval in Italian politics or a deteriorating labor market are among the risks that could turn bund yields negative, according to strategists.
Subzero yields on 10-year bonds would mark a step back in time — to 2016 — when the European Central Bank was pumping money into the economy in an effort to reflate it. Now investors are seeking safety as they wonder if the institution has missed its chance to lift its deposit rates from a record-low -0.40% before the next global downturn strikes.
"If the German consumer continues to retrench, then bund yields can go below zero," said John Taylor, a money manager at AllianceBernstein (AB), which oversees $550 billion in assets. "I thought the end of quantitative easing would have had a bigger impact but it appears that the disappointing data has continued to push yields down further."
German 10-year yields were at 0.12% Wednesday, having touched 0.08% last week. They fell below zero just ahead of the Brexit referendum in June 2016, before recovering from October that year. Yields on German tenors from short-term bills to bonds up to eight years are already negative.
Industrial production data Wednesday added to fear of an economic contraction in the region, falling at the fastest pace since the financial crisis.
Investors might choose to hold negative-yielding debt for a number of reasons. They may have to — by following a benchmark bond fund that contains a high proportion of safer assets such as bunds. They may think the securities will continue to rally, benefiting from the increase in price, or that the currency underlying the bond may climb to boost returns.
The global stock of negative-yielding debt has surged to the highest level since 2017 as portfolio managers grow increasingly pessimistic about the state of the economy. It has climbed to $9 trillion from below $6 trillion in October, according to a Bloomberg Barclays index.
"Recession risk is everywhere, but more imminent in Europe than the U.S.," Citigroup strategists led by Jamie Searle said in a note.
While average yields on short-dated euro corporate bonds remain well above zero, the rally in credit this year has increased the number of negative-yielding ones. There were only 13 in early January, yet this group has since ballooned to 64 members. It took until early 2017 for such bonds to follow comparable German government debt into negative territory — after the ECB began buying company debt in mid-2016.
Morgan Stanley (MS)'s "bull case" is for bund yields to touch zero if the labor market deteriorates or there's a reversal in positive wage data, leading investors to price in the probability of a deeper euro-area downturn. Negative yields are also not the base case for AllianceBernstein (AB), with Mr. Taylor putting the risk at 25%.
"Whilst the world looks deflationary today, it's nothing like the mindset in 2016," said James McAlevey, a portfolio manager at Aviva Investors. "The long duration grab for yield that permeated investors thinking and behavior back then was much more profound. So I don't think the flattening can be driven much beyond current levels."
It is likely to take a political shock to force subzero yields, as it did with the Brexit vote. The continuing threat of a U.S. government shutdown, trade tensions with China, the U.K. crashing out of the European Union without a deal next month or populist victories in the region's parliamentary elections in May are all on the watch list for fund managers.
"The possibility of 10-year nominal bund yields slipping into negative territory certainly cannot be discounted," said Rabobank strategists including Richard McGuire. "Given the slew of seemingly diverse but in actual fact populist-related news, one could argue that the odds are tilted in favor of such an outcome."