When the results of the UK’s EU referendum emerged last Friday morning, the share price of MetLife, the stolid American insurance group, tumbled. In the course of two days its stock fell 14 per cent, making it one of the worst performers on the American indices.
At first glance, that seems bizarre. MetLife does not sell policies in the UK and its exposure to Europe is small. So it should be shielded from the more obvious potential effects of the vote that are looming over UK companies, eurozone banks and Wall Street giants, such as a European recession or a loss of business and influence for the City of London.
But MetLife has a vulnerability that highlights one impact of Brexit that will have further-reaching consequences. Market actors have turned their attention to the wider outlook for interest rates. Most notably, in recent days, investors have sharply downgraded their expectations for inflation and interest rates, not just in the UK but across the west.
That has nasty implications for asset managers of all stripes, including insurance companies, which need to earn decent returns to pay policyholders. It is also painful for banks, since low rates typically hurt their earnings.
When future historians look back at the Brexit shock, they may conclude that this shifting rate outlook is one of the most important ripple effects of the Leave vote - even if the implications of a Brexit for bond prices look less thrilling than, say, the political soap opera around Boris Johnson, the leading Leave campaigner who has pulled out of the race to be UK prime minister.
To understand this, take a look at the numbers. A couple of years ago negative-yielding bonds - which, in nominal terms, pay less at maturity than investors initially paid - were rare. But this week, Fitch Ratings agency calculated that there is now $11.7tn worth of sovereign debt in the global market that carries negative nominal interest rates.
That is extraordinary. Furthermore, this pile has swelled by $1.3tn in the past month alone, and includes $2.6tn of long-term bonds (those with more than seven years of maturity). Meanwhile, the pile of bonds with a yield that investors used to consider normal - above 2 per cent - is barely worth $2tn.
Most of this negative debt sits in Japan and the eurozone. But rate expectations in the UK and US are sliding, too. The US Treasuries market, for example, now expects a mere 125 basis points of rate rises in the next decade, with barely any hikes in the next two years. Indeed, one of America’s largest hedge funds is now warning its clients that “markets in aggregate are discounting . . . effectively no monetary tightening for a decade across the developed world”.
Can this gloomy market prognosis be believed? Maybe not. After all, the global economy is still growing overall, with lacklustre expansion in the US. A dash to havens may also have influenced some of the recent bond price swings. If the political climate stabilises and the Remain camp’s prediction of economic disaster in Europe turns out to be overblown, the downbeat outlook of the markets could be reversed.
But, there again, it is also possible to draw an even gloomier conclusion: that Brexit has crystallised and intensified more fundamental investor fears that the west is slipping ever-deeper into economic stagnation. After all, that $11.7tn negative-yield bond pile did not just emerge after the referendum but has in fact been swelling for many months.
Either way, the one thing that is clear is that unless that pile suddenly and unexpectedly shrinks, investors and policymakers need to prepare for yet more ripple effects in the months ahead. For one thing, asset managers and insurance companies will see their earnings slide unless they start buying more risky debt - which will bring dangers of its own.
Second, the central banks’ policy dilemma will intensify since they will face pressure to engage in further loosening monetary experiments - even though it is unclear that these unprecedented measures are actually boosting growth.
And there is another nasty twist. Negative, or low, rates may exacerbate income inequality, too, since these typically raise the value of assets that wealthy people own, such as property and stocks. If so, that might create even more political populism, sparking more political uncertainty and economic gloom.
The real ripple effects of Brexit, in other words, may have barely been seen yet. All eyes are on the political polls and trade flows, and on those bond prices.
