The upside-down world of negative yields

As negative-yielding corporate debt passed the trillion-dollar-mark, investors may not fully appreciate the risks they face

The upside-down world of negative yields

Given the years-long persistence of the global low-interest-rate environment, the existence of negative yields may have lost some of its shock factor for some. But as they start to grip a larger part of the market, experts warn of growing risks that investors may not appreciate.

One only has to look at a recent tweet unleashed by U.S. President Donald Trump, who has been calling for the Federal Reserve to lower rates more aggressively. Shortly after news that Germany was offering 30-year bonds with a negative yield for the first time ever, Trump said the country “is actually being paid to borrow money.”

But as explained in a CNBC News report, the negative yields actually reflect the high premium investors have been willing to pay for bunds in hopes of capturing gains when the price of the bond goes up.

Citing J.P. Morgan, the news outlet noted that negative-yielding debt now equals nearly a third of tradeable bonds worldwide. The spectre of negative yields has also cast its shadow over corporate debt, where Jim Bianco of US-based Bianco Research said negative-yielding issues have risen from just US$20 billion in January to exceed US$1 trillion.

“The interest rate risk that these bonds carry is huge,” Bianco told CNBC News. “The financial system doesn’t work with negative rates. If the economy recovers, the losses that investors [in negative-yielding debt] would take are unlike anything they’ve ever seen.”

According to him, most of the world’s negative-yielding corporate debt originates from Switzerland, with some coming from Japan.

While a lot of the flight to fixed income securities of late has been borne out of a desire to load up on haven assets, a cohort of investors could be following a more aggressive thesis. Essentially, they are betting that rates will stay low and prices on bonds will rise, which would allow them to capture capital gains from fixed-income securities.

“Should rates start to rise even a little, that will start to eat into the capital appreciation that bond holders have been enjoying,” CNBC said. Bianco has said that a 2-percentage point increase in yields on Swiss bonds would amount to a 50% loss for holders.

Germany has arguably become the poster child for negative rates on sovereign bonds, as the yields all along its curve have gone into sub-zero territory. Prices have been pushed up dramatically, with buyers paying the equivalent of US$195.87 for every US$100 in 20-year German bunds.

Bianco points to moves by the European Central Bank, along with other entities, to pump money into the financial system as the catalyst for the negative yield trend. “They’ve so flooded their financial system with money that there’s not enough alternatives,” he said, explaining that investors are just getting swept into a negative-yield environment as a result.


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