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  8 | INVESTMENT EXECUTIVE NEWS The mantra is safety
but they have higher price risk in their longer durations. And subna- tional bonds and corporates with still higher yields pay even better, but make less credible promises of principal repayment.
For now, the mantra is safety and the intrinsic insurance costs of the most secure bonds don’t seem to matter. “Bonds now have less shelter if we start from a low- yield environment,” says Avery Shenfeld, chief economist with Toronto-based Canadian Imperial Bank of Commerce. “That makes sense, [as] longer bonds have less shelter value.”
Where we go from here is the issue. Precaution underlies much of the drive to low and negative rates on government debt. “What we know is not about funda- mentals, but about fear,” says Chris Kresic, head of fixed-in- come and asset allocation with Jarislowsky Fraser Ltd. in Toronto. “Investors are buying liquidity at any price. The trad- ing is so one-sided at times that market-makers are using deriva- tives to make trading work.”
In this angst-driven market, liquidity, not return, is the con- cern. The lower rates go, the more households hoard cash. That cash pays little or even less than nothing is not the point. But to maintain income, savings are rising. According to a Bloomberg
April 2020
LP report on March 17, house- hold savings in Germany have reached 11.2%, the highest per- centage in a decade. The report also notes that savings rates in Denmark and Sweden are near all-time highs. Rather than get- ting people to spend more, low and negative rates are pushing people to save more in order to maintain their spending power.
For now, the mood of the bond market is protective. An investor who just wants to speculate on rate cuts can add duration risk by buying long bonds. “If you believe that there are rate cuts coming before we get to zero, then you can buy long bonds outright,” notes Michael Gregory, deputy chief economist with Bank of Montreal in Toronto. “If you have strong conviction that the recent [rate] cuts are not the last of the [U.S. Federal Reserve Board] and Bank of Canada moves, you can make gains if they do cut.”
Other investors are making these bets, too. With near-zero yields on government debt, the market is now being run for speculation, not income. Risks, especially in long bonds, are immense. When the coronavirus abates, as eventually it must, there will be a rush to equities paid in part by sales of bonds. There is little safety in overpriced assets primed for a drop. IE
   Government bills offer a haven as long-dated bonds and equities gush losses
the beginning of February.
The scale of the problem is the “fear” premium. Stocks’ value depends on investors’ views of future earnings, sales, debt lev- els, and more. For government bonds, tax collections under- lie ratings and rates. Whether Canadian and U.S. T-bills go to negative yields, as many European bonds have, is both a political matter for policy-mak- ers and the practical matter of
providing banks with liquidity. Bonds’ interest payments reduce the theoretical cost of buying safety. But dropping yields have driven up the cost of that safety. Negative yields mean the insurance premium between cor- porate bonds’ or longer-term gov- ernment debt’s positive yields and short-dated bonds’ negative yields is rising. Longer bonds that pay at least part of their way with higher yields have a lower insurance cost,
in bonds, the financial
crisis is manifest. Shorts — treas- ury bills sold at discount and due in a year or earlier — are holding up well.
For example, Canada sover- eigns due in 365 days or earlier tracked by iShares XSB ETF were down by just 2.4% for the six- month period ended March 18. The slight decline was a retreat from enthusiasm or fear the week before, when T-bill prices rose a bit too high. But the bond market is far better than that of shares. Stocks in Canada and the U.S. have lost 20% or more of their value vs the end of 2019, depending on your choice of index.
The stampede to safety is evi- dent in U.S. treasuries, which, in addition to certainty of payment, have the greatest liquidity of any financial asset in the world. On March 26, two-year T-bill yields were 0.30%, down from 0.84% at
the beginning of March, while 10-year T-bill yields were at 0.83%, down from 1.10% at the top of the month. Yields, of course, move inversely to price. Investors are choosing cash-equivalent shorts over longer, better-paying bonds. Liquidity, not yield, is the goal.
In Canada, the process is the same. At the March 25 auc- tion, federal three-month T-bills dropped their yields to 0.49% from 0.64% two weeks earlier. Six-month T-bill yields dropped to 0.45% from 0.58% two weeks earlier, and one-year T-bill yields dropped to 0.44% from 0.55% two weeks earlier and from 1.64% at
  “The trading is so one-sided at times that market-makers are using derivatives to make trading work”
    Lifecos vulnerable to Covid-19
Financial markets’ volatility and lower bond yields will have a big impact on insurers’ capital and profitability
U.S.: Who’s exposed to corporate bonds? U.S. corporate bond ownership in 2007 and 2018
25.1% of U.S. corporate bonds held by insurance companies
 2007 2018
the impact of covid-19 on
life insurers will probably be attributable mainly to adverse movements in financial mar- kets, according to Toronto-based DBRS Morningstar Inc. “The impact on insurance claims is expected to be manageable,” a recent report from the firm states, “given the relatively low mortality rate for infected individuals.”
In a separate report, the London office of New York-based Moody’s Investors Service Inc. agrees: “For global insurers, mortality levels would need to rise significantly to trigger a substantial rise in claims for life insurers, although there is still a lot of uncertainty as to the ultim- ate level of deaths.”
However, the Moody’s report forecasts second-order effects, such as volatility in financial markets and lower bond yields, to have a bigger impact on insur- ers’ capital and profitability. The report added that Europe-based insurers “are particularly sensi- tive to financial market volatility and movements.”
Moody’s report doesn’t “expect a significant claims impact” for non-life insurers.
Still, life insurers’ exposure to corporate bonds could be a prob- lem. American insurers’ assets invested in corporate bonds in the U.S. totalled US$13 trillion
in 2018, up from US$10 trillion in 2007, just before the global credit crisis hit.
The increase “has been fuelled in part by subprime-type loans,” which now total more than US$1 trillion, says Krishen Rangasamy, senior economist with National Bank Financial Inc. in Montreal. “If leveraged loans go bad, that has the potential to freeze the corporate bond market and the entire financial system,” he says. Such a financial shock “would likely spill over quickly to a real economy that’s already weakened by virus-related disruptions.”
Any freezing of the U.S. bond market would be felt in Canada immediately. Canadian life insur- ers hold large amounts of fixed- income investments to back up their long-term insurance liabil- ities, as do property and casualty insurers for their shorter-term lia- bilities. Mutual funds need corpor- ate bonds for their fixed-income and balanced funds. Brokerages would also be hurt.
On the plus side, the DBRS report states, over the past few years, insurers “have improved the comprehensiveness of their risk management policies and procedures. There are currently more developed risk manage- ment procedures in place and better monitoring of current and emerging risks.” IE
Non-U.S. investors
Financial institutions
Pension funds
Broker- dealers
Mutual funds and ETFs
Households and other
                   Source: NBF Economics and Strategy (data via IMF)

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