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Investing in This $480 Billion Bond Market Means Forgoing Yield

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  • Denmark’s covered bond market, world’s biggest, holds auctions
  • Liquidity and cross-currency swaps are the real attractions

Investors in the world’s biggest covered-bond market probably won’t get any respite from negative yields this year.

The $480 billion market in AAA-rated Denmark is holding its quarterly auctions for refinancing mortgages over the next couple of weeks, and bonds already trading in the secondary market are testing record lows, according to Jeppe Borre, an analyst at Nykredit Realkredit A/S, the country’s biggest mortgage bank.

That’s a signal that yields on the $16 billion in short-term bonds that mortgage banks are offering through November will probably match previous lows, and may even drop further below zero.

“The global economy is improving, but interest rates and inflation are still relatively low,” Borre said in an emailed response to questions. “And in this low interest rate environment, combined with the high level of security that Danish mortgage bonds provide (AAA), the demand for the bonds is high.”

In an early sign that the weeks’ auctions will end again in sub-zero yields, the rate on one-year bonds auctioned Friday by Nykredit clocked in at minus 0.21 percent, the mortgage bank said. The record low is minus 0.23 percent.

Yields on bonds maturing over the next five years have dropped in some cases to as low as minus 0.50 percent in Copenhagen. 

Foreign Appetite

A steady influx of foreign investors is in part driving down returns. Since 2010, they’ve roughly doubled the amount of bonds maturing in less than a year, and tripled their holding of 30-year fixed-rate securities, according to central bank data. Combined, foreign investors now hold roughly a quarter of the market.

In fact, the range of investors is now at its greatest in more than a decade. The central bank last month characterized as “low” the concentration of ownership in 80 percent of long-term, fixed-rate bond series (“Low” means no single investor holds more than a fifth).

What foreign investors lose in yields, they gain on the cross-currency swap, according to Danske Bank A/S, Denmark’s largest bank. 

“The short end is dominated by foreigners, particularly because of the basis swap in dollars, and if they continue to be there -- and we expect them to be -- the front end will trade around these levels,” Jan Ostergaard, chief analyst at Danske, said by phone. The market’s considerable liquidity and negative central bank deposit rates also weigh on decisions to invest, he said.

“The deposit rate is minus 65 basis points, so a one-year bond at minus 55 basis points may look expensive, but not if you just need to place your money,” Ostergaard said.

Record Holder

Denmark is home to the world’s biggest covered-bond market, according to the European Covered Bond Council. It also boasts the world record in the longest stretch of sub-zero rates, after the country’s central bank first went negative in 2012. Once considered experimental, with unpredictable consequences for markets, the policy is now entrenched. Negative rates probably will persist into the next decade, according to Nordea.

Banks including Nykredit and the mortgage units of Danske, Jyske Bank A/S and Nordea Bank AB will in the coming weeks offer around 100 billion kroner ($16 billion) in mostly krone-denominated bonds with maturities of one, three and five years, according to estimates by Danske. They’ll also be setting new interest rates on floating-rate bonds.

The likelihood of negative yields won’t deter investors, Ostergaard said. The bonds offer a pickup that won’t disappear unless they perform “massively” or there’s a change in the cross-currency basis and “we don’t see that happening” given the current signals from the U.S. Federal Reserve and the European Central Bank, he said.

“The Fed trend is to tighten so the pickup is in place, unless the market starts to price in the ECB doing something. But that probably won’t be next year,” Ostergaard said.

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