How Negative Yield Bonds Work
A bond has a negative yield when the investor collects less money when the bond is mature than they paid to buy the bond. In short, the bond issuer is paid for issuing the bond. The buyer of the bond is paying for holding the bond. The reasons for buying a negative yield bond are several. In normal times, a bond may trade at a greater price than when it was issued due to interest rate fluctuations. And, in times of deflation, money increases in purchasing power and negative yield bonds become the norm.
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Why Investors Buy Bonds With Negative Yields
At times when an economy is weak, deflation may set in. Money increases its purchasing power over time instead of losing it as happens with inflation. At such times, a bond with a small negative yield might be expected to gain in purchasing power by the time it is redeemed. Likewise, when an investor expects to see a currency rise in value against others, buying negative interest rate bonds in the currency that will strengthen will result in a profit when converted into a weaker currency. Other reasons include insurance companies that must hold part of their assets as bonds no matter how poor the yield is.
Corporate Bonds With Negative Yields
Investment grade corporate bonds with negative yields have become common in the European Union and Great Britain. In June of 2020 negative yield corporate bonds tripled in value over the previous month. About 332 billion euros worth of the 3.39 trillion investment-grade bonds in the EU had negative yields. This compares to 61% of government bonds in the EU and 48% of government bonds in the UK. The companies issuing these bonds are blue chips like Siemens that issues $1.6 billion in negative yield bonds recently.
How Can a Bond Have a Negative Yield?
Because we usually think of bonds as something that gives us a safe return on our investment over a specific period of time, negative yield bonds seem like a contradiction in terms. A bond has a negative yield if you can expect to get less money back when the bond matures than you put into it when you purchased it. When this happens during normal times it is a result of interest rate changes and having to sell the bond before maturity. But, now with economies weakened across the globe, we can expect that the purchasing power of money will rise with deflation. Thus you can purchase bonds for which you will receive less money at maturity but which may give you better purchasing power.
How Do Bond Yields Go Negative?
Bond yields go negative in two ways. The first is that you purchase a bond at a low interest rate and the rate goes up. If you choose to or have to, sell the bond, you will have a negative yield. The second way, which we are seeing now, is when deflation hits an economy and interest rates fall. They may go so as to be negative. In this case, you buy a bond for which the interest rate is negative. When you hold the bond to maturity, you will receive less money than you spent to get the bond. Investors may consider this to be a safe haven investment in times when economic chaos drives down the stock and real estate markets, makes money scarce, and drives up the purchasing power of the currency.
Impact of Negative Bond Yields
There are two ways to look at the impact of negative bond yields. The first is that investors choose to lose a little bit of money instead of risking the loss of more money. They buy government bonds with a slight negative yield, secure in their belief that they will be paying a slight premium to avoid huge losses. The other view is that negative yields are a losing proposition. Which of these is true always depends on what happens next to a currency, interest rates, stocks, real estate, precious metals, and cryptocurrencies. And, all of these depend on the stability of the economy, the markets, and today on the coronavirus.
Negative Bond Yield History
Japan has years of negative yield bond history. This was first tied to the deflation that hit the country around 1990 when its economic boom collapsed in the wake of a crisis of hidden debt. More recently, negative rates have occurred in the EU and UK as well. Negative yields have always been the end result of slowing economies, progressively lower rates, and a slide into negative territory. In almost all cases, negative yields are accepted as a way to protect money against loss by accepting a small “fee” for having the government or a corporation hold and “protect” your money.
Who Buys Negative Yield Bonds?
Investors who want a safe haven in weak economies often accept negative yields as an alternative to risking a stock market or real estate crash that would result in huge losses. And, insurance companies that are required to hold a portion of their assets as bonds are also faced with the necessity of buying and holding negative yield bonds when there are no safe alternatives. When rates for investment grade debt are negative, there are also positive yields to be found if you are comfortable with junk-grade bonds.
