QE side effect: Corporations are getting paid to borrow

We have all seen pharmaceutical commercials on TV where a listing of common side effects may include diarrhea, nausea and drowsiness. In today's financial markets, central banks are expanding their balance sheets by trillions of dollars annually and new side effects are on the way. This week saw a new milestone in the world of negative interest rates, when Henkel and Sanofi became the first public companies to sell new Euro bonds for more than the buyers will get back.

Yes, you read that correctly. Investors are paying for the privilege of loaning a corporation money. We first saw this with European and Japanese government bonds but this is a first for corporate bonds which carry significantly more credit risk. While this is a pretty horrible side effect for investors, it is essentially helicopter money for corporations who can take this “free” money to buyback shares, make acquisitions and/or invest it to grow their business. Henkel sold €500 million of 2-year debt with a yield of -0.05%; and Sanofi sold €1 billion of 3.5-year debt at a yield of -0.05%.

Thanks to aggressive bond purchases from the European Central Bank (ECB,) corporations are getting free money, and this trend is set to continue for the foreseeable future. The ECB launched its corporate bond buying program in June and has bought over €20 billion of corporate bonds as of Sep. 2. Yields on corporate debt have plunged in recent months as investors have pushed up prices in the scramble for returns. Roughly €706 billion of eurozone investment-grade corporate bonds traded at negative yields as of Sept. 5, or over 30% of the entire market, according to trading platform Tradeweb, up from roughly 5% of the market in early January.

Stock market side effects

With negative rates, it appears that the bond market is in bubble territory and one wonders how much further negative can rates go? In terms of the stock market, equities should remain favorable on a relative basis. If bonds have a negative yield, investors are forced to either sit on cash that earns nothing or they need to move to the equity market in search of high dividend paying stocks. We expect this bizarre situation in the bond market to continue pushing fund flows into equities.

If negative rates come to the US, what will your investment strategy be?

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