Wake Up, Europe

Around the Curve

Wake Up, Europe

Negative interest rates offer a unique opportunity to build or borrow at rock-bottom costs.


In June of 1984 I was a young portfolio manager finding myself at odds with the wisdom of the day. Yields on 30-year Treasuries had rebounded from 10% to 14% as inflation had bounced from 2.5% and was running at just over 4%. The leading sages of the day were very bearish on bonds, as they had been rewarded for that view for the prior 20 years. At the time, I loaded up on 30-year bonds and 30-year zero-coupon bonds—those were positions we can only dream about today. However, the point of this blog is not that there was great value 35 years ago. Instead, my point is that the U.S. was issuing bonds that were a ridiculous burden on Americans. Real 30-year bond yields 10% higher while the rate of inflation began a secular decline is something we have seldom seen again—and a waste of taxpayer money in my opinion. The great inflation had been broken and did not need to be crushed again.

Now, we have Europe. Something is not working in Europe, but the authorities don’t seem to be able to figure it out. European Central Bank (ECB) rates hit zero in 2012 as President Mario Draghi said he would do whatever it took to counteract his predecessor Trichet’s disaster of a rate rise in 2011. Rates continued to drop reaching minus 40 basis points (bps) in early 2016. This was all in the effort to get inflation to rise. As of today, money supply is growing, but inflation is not. We believe that the ECB has done all it can and that what Europe needs is demand. Central bankers seem to harken back to the world where they could turn on the credit spigot and borrowers would line up. The last decade’s challenges have reminded borrowers that they must pay back the principal, and the ECB’s fears about deflation make them fearful as well.

So, what is Europe to do? Europeans should be happy to borrow at negative yields and use the proceeds to invest in much-needed infrastructure that might increase the region’s growth rate. One might go so far as to imagine Germany spending money on Italian infrastructure that could have positive feedback into German gross domestic product (GDP) by a few basis points. While in 1984 I was incredulous to pay 10% real for my government’s debt, it now seems equally foolish to not borrow money at negative cost to invest in projects that may have a positive return. I don’t think finding such projects is a high hurdle.

Let’s play a hypothetical mind game for a minute. Germany issues ten times its GDP in 10-year Bunds at the current yield of -0.4%. Germany issues the bonds to the ECB for newly minted €1 billion notes, at the current price of 104% of par. The 33,000 notes—100% of par value—are then put in the vault, so they don’t get “loose” and cause the much-feared German hyperinflation. With the 4% bonus—in other words, 40% of GDP—the government either spends like mad on infrastructure or pays down two-thirds of outstanding German debt.

While this hypothetical scenario is highly unlikely, policymakers are already down Alice’s rabbit hole of free debt, so why not try to fully enjoy the opportunity? More realistically, eurozone countries could issue negative-yielding debt to spend on infrastructure, or anything that contributes to growth, at least until rates move above zero. Bond yields were crazy high in the early 1980s and now they’re crazy low—therefore, Europe should wake up and take advantage of this negative yield anomaly.


The European Central Bank (ECB) is the central bank of the European Union (EU).

One basis point (bps) equals one ohe-hundredth of one percentage point.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

Bunds refers to bonds issued by Germany's federal government. Bunds are available in 10- and 30-year maturities.

Par/Par value refers to the face value of a bond. The market price of a bond may be above or below par, depending on factors such as the level of interest rates and the bond’s credit status.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.


Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.