Why would purchasers ever buy bonds at a money-losing price? Buying something in order to lose half a percent, or whatever the negative yield is, seems about as logical as hitting one’s thumb with a hammer on purpose. And yet there are logical reasons this happens.
First off note that, when it comes to government bonds, no person or committee decides to make the yield negative. Instead there is such a strong demand for the bonds that buyers keep bidding the price up, even after the yield hits zero and falls below zero.
As for why bonds still get bids when yielding less than zero, there are multiple possibilities for buyers’ rationale. The first possibility is speculative price appreciation. If an investor buys sovereign bonds at a negative yield because he thinks the yield will go more negative still — meaning the bond moves higher in price — then he is simply looking to “buy low and sell high,” or rather “buy high and sell higher.” Other investors, typically banks or large institutional investors, will buy negative-yielding bonds as a “least-bad alternative.” By that meaning, these entities are forced by their charter or investment mandate to own some type of securities, or some mandated mix of stocks and bonds; if everything in their investment landscape looks terrible, buying bonds for a small fixed loss might be their “least bad” option.
Then, too, sometimes sovereign bonds see a rush of bids from safe-haven buying. When markets are in crisis, or there is otherwise a lot of turmoil, investors can rush into government bonds as a safe place to park their cash. If this happens in large enough volume, when yields were already low, the bond price can go negative and stay there.
It should go without saying by now, but negative-bond yields are a very bad sign for a nation’s economy, or the global economy on the whole when there is $10-$20 trillion worth floating around. This phenomenon means the long-run outlook for economic growth is so poor, or so worrisome, or both, that investors can think of little better to do with their cash than pay a holding fee to keep it safe.
The final, and most frightening, reason for negative-bond yields is the presence of outright deflation. If prices nearly all across the board are contracting at, say, a 5% annual rate, then losing 1 or 2% on a fixed basis — for investors with no better option — might actually be a good deal.
In sum, negative-bond yields are a harbinger of looming deflation and nonexistent economic growth.
Jeff W, Guest
All posts made on this website are provided for information purposes only. None of the information here is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, Company, or fund. Before making an investment decision, you should seek the advice of a qualified and registered securities professional. Candlr is not receiving payment or commissions from companies for shared content on Candlr website unless its specified. View full disclaimer HERE.