Why buy at negative yield?
According to The Financial Times, the average yield across German government bonds fell to zero for the first time in its history last Monday. German bonds with a maturity of up to nine years are now trading at negative yields, with the benchmark 10-year trading just above zero at 0.13%
With yields so low, we ask why would anyone still be in the market buying this debt?
In less than two years, world of negative interest rates has become the new ‘norm’ and central to mainstream monetary policymaking. Even US has reportedly considered whether negative rates might work for them in future.
The number of bonds trading with negative market interest rates has now reached $7t. This includes Japanese and Swiss 10Y bonds, whilst Germany’s 10Y has come very close to sub-zero territory. This number looks set to grow as the ECB’s moves into corporate bond buying. In March, for the first time ever, a corporation sold a bond at a negative rate – Berlin Hyp AG.
Buying negative-yield bonds – which essentially means paying money for the privilege- looks like a fool’s game. But, while buying a bond with a negative yield looks like a guaranteed way to lose money, investors are still lapping up the debt.
So, why buy at negative yield?
- Capital Gains
Central banks have sought to stimulate economies by increasing money supply and improving liquidity in the financial system. They hope to encourage lending by cutting borrowing costs, with the ultimate aim of boosting economic growth. One way to effect this is by purchasing government bonds – and selected corporate in the case of the ECB – resulting in increased prices of even the most-expensive bonds, while dropping the yields in the process.
Negative-yield bonds seem worth buying as long as yields keep declining – and the price keeps on rising. Investors with these assets are effectively paying for the privilege to hold hoping that someone else will be willing to pay more for the asset in the future, rather than it expiring and losing money. You could say that they are waiting for the greater fool…but it hasn’t been foolish so far to hold these bonds.
- Greater certainty
Investors are seeing an increase in their purchasing power as deflation continues to persist in the euro area. Nevertheless, since the beginning of this year, equities and commodities have shown considerable volatility. The default rates on higher-yielding corporate bonds are rising and holding money with central banks in the Eurozone, Denmark, Japan and Sweden means negative returns. Therefore, buying a government bond could appear to be a prudent choice and negative yield could be viewed as a small cost compared with a bigger loss that investors may incur in the equities or commodities market.
- A good choice?
Deflation can make the real – or inflation adjusted – return on a bond with negative nominal interest positive. For example if a bond yields minus 0.5 percent, but CPI is minus 1 per cent. This equation could look even better if you add in some currency appreciation.
- No choice
For institutional investors with conservative investment mandates, such as pension and insurance companies, there is little choice but to buy bonds in spite of low rates
So what’s the problem?
As we’ve commended before, there are opportunities but also significant dangers of living in a NIRP world. José Viñals, a senior IMF official, has warned that negative rates could become more damaging for society the longer they persist, undermining the viability of life insurers, pensions and savings vehicles. The policy could be counterproductive to its aim of improving the economy, if consumers invest and save more now for retirement. Of course, this could be said of any cut in interest rates, but there has to be a plan beyond this – central banks cannot keep cutting indefinitely.