Chart: Government bonds with negative yields

Global financial markets endured a day of turmoil on Thursday as investor fears rose over the cost to banks of negative borrowing rates imposed by central banks desperate to stimulate flagging economies.

Janet Yellen, chair of the Federal Reserve, played down the chances of the US central bank following the European Central Bank and the Bank of Japan by lowering rates into negative territory but acknowledged that the option remained on the table. Her comments to the Senate came after Sweden shifted rates deeper into negative territory, raising concerns over the extreme actions likely to be taken by central banks.

Equity markets sold off sharply, with the FTSE All-World stock index entering bear market territory after falling 20 per cent from last year’s peak. Investors pushed up prices for perceived safer assets such as government debt, the Japanese yen and gold, which experienced its biggest one-day percentage gain since 2013.

Financial stocks suffered another day of heavy selling. The Stoxx 600 European banks index dropped 6.3 per cent to hit its lowest level since the eurozone debt crisis, and losses for US institutions contributed to sharp declines for the S&P 500.

The benchmark US equity index slid 1.2 per cent by end of trade to settle at 1,829, after touching its lowest level in two years. A late-day rally in energy prices buoyed markets before the close, with Brent crude rising 1 per cent to $31.14 a barrel.

Investors are worried that policymakers’ adoption of negative borrowing rates will become prolonged, further distorting the financial system and limiting the ability of banks to extend loans to the broad economy profitably.

“Markets have evidently lost their belief in the powers of central bank policy,” said Andrew Law, head of Caxton, a longstanding macro hedge fund. “Markets have lived on the basis that central banks were there to provide liquidity and support, and that this would be enough.”

After Sweden’s Riksbank cut its main overnight borrowing rate by 15 basis points to minus 0.5 per cent it warned that monetary policy could be made “even more expansionary if this is needed to safeguard the inflation target”.

Both the Bank of Japan and the European Central Bank are expected to cut rates further into negative territory this year as they seek higher inflation, a policy objective being compromised by their stronger currencies.

The prospect for low inflation and slowing growth has prompted a rush out of risky assets. “Safe assets are becoming the default investment and money is falling out of everywhere else,” said John Wraith, head of UK rates strategy at UBS.

The yield on 10-year UK government debt reached an all-time low of 1.23 per cent. The yield on equivalent US Treasuries touched 1.53 per cent, its lowest level since August 2012. As the coupon paid on such bonds is fixed at the time of issue, their price rises as market interest rates fall.

The yen gained 1 per cent against the dollar, to trade at Y112. Gold rose more than 4 per cent to $1,247 per oz.

Some blamed the turmoil itself for feeding a cycle of pessimism, making investors and banks unwilling to trade and adding to the volatility of price moves.

Mr Wraith said: “There is little in economic data that can explain these extraordinary moves but the worry is that when markets behave like this and it feeds through to the real economy it can affect confidence and become self-fulfilling.”

Additional reporting by Elaine Moore, Thomas Hale and Eric Platt

Letter in response to this report:

Central bank policy is founded on flawed analysis / From Michael Wickens

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