As soon as you wrap your head around this, the first thing you encounter is the massive amount of debt the world over. Most of it is pretty low quality. If you are talking about high-quality debt, it isn’t going to be Greek or Russian or Argentinian debt; it isn’t even going to be Italian or French debt. It will be bonds issued by the U.S., Germany or Japan. That’s pretty much it for the high quality, sovereign bonds offered in any real size.
We can certainly find high-quality paper from Switzerland or Singapore or Sweden or even Taiwan (Norway is rated AAA, but it runs a surplus). Throw in Canada, Finland, Australia and the Netherlands and you have pretty much covered the universe of other A-rated countries, though none of them issues a whole lot of debt. Hence, although there may be no shortage of quality issuers, there seems to be a shortage of quality sovereign securities. I understand that might be hard to imagine given all of the debt worldwide, but the key word is quality. There’s lots and lots of bad paper, but surprisingly limited quantities of good paper.
Before you collectively start ranting about QE, we already know that the Fed has been a buyer of U.S. debt for more than five years. Not too long ago, the Bank of Japan joined in with its version of QE. Now, the European Central Bank is in the game as well. But central-bank buying doesn’t account for the shortage of debt that explains the negative yields we see in parts of Europe.
My back-of-the-envelope calculation (that’s the technical term for a fair guess) is that demand exceeds supply by as much as $1 trillion to $2 trillion a year. That is what has been forcing bond prices higher, and driving negative yields.
There are other forces that account for the dearth of debt. The three biggest are:
Market rally rebalancing: Many traditional portfolios made up of 60 percent stocks and 40 percent bonds — often managed by large pension funds, institutions and other asset allocators — follow a simple approach to rebalancing. As equities rise in price, these investors sell some stock and buy bonds to re-establish the original asset weightings. The 200-plus percent rally in the Standard & Poor’s 500 Index since March 2009 is thus a large driver of bond purchases.