InvestorQ : What is meant by negative yield bonds and why are the important? What is their interpretation for the Indian context?
Sam Eswaran made post

What is meant by negative yield bonds and why are the important? What is their interpretation for the Indian context?

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swati Bakhda answered.
8 months ago


According to Bloomberg estimates there are bonds worth over $10 trillion that are carrying negative yields, predominantly in Europe and Japan. Negative interest rates mean that you actually pay to deposit money with bank. The question then is why should any rational investor ever want to buy bonds that are giving negative yields? There are 4 broad reasons why there are still investors who want to buy negative yield bonds...

· Many institutions like insurance companies, endowments, pension funds are required by statute to invest a basic minimum corpus in government bonds. These institutional investors will have to necessarily invest in these government bonds even if they carry negative yields. This is more of a statutory compulsion.

· Then there are active investors in negative yield bonds. At the end of the day, what matters is real return (return net of inflation) and not nominal returns. If the investor expects further fall in prices and the economy slipping further into deflation, then negative yield bonds may still make sense as their real yields may still be positive

· Thirdly, there are investors who would buy negative yield bonds betting on a further fall in interest rates. Take the case of ECB interest rates that are currently quoting at -0.3%. If the expectation is that the ECB may cut rates lower to -0.5%, then buying a negative yield bond will still give you capital appreciation.

· Lastly, there is an interesting currency game. This is very true of countries like Japan, which run current account surpluses. There is a strong demand for Japanese government bonds although they carry negative yields due to the strength of the Yen. The JP¥ has appreciated consistently against most currencies in the last one year due to safe haven buying of Yen. This may impel investors to buy Japanese Yen Bonds to benefit from currency appreciation even though they carry negative rates.

There are 6 key implications of negative rates that we need to focus on…

What will get impacted by negative rates?

What are the implications?

· What do negative interest rates mean for central bank monetary policy?

· Central banks like ECB and BOJ are currently in a corner as they do not have room to cut rates any further to prop growth

· The theory that cutting rates will spur growth has not been evident in the last 6 years of loose monetary policy globally

· Central banks have used negative rates more to suppress their currencies versus the dollar to spur exports. Even that has not worked as global trade has shrunk in the last 2 years.

· Negative interest rates makes fiscal deficit palatable, but that can be misleading…

· Since rates are negative, a high ratio of Debt/GDP look palatable, which can be misleading when rates start to rise

· Negative rates may spur households and governments to go on a spending spree due to availability of easy money

· What does negative rates mean for treasurers of corporates

· Treasurers have a unique dilemma of matching their long term liabilities with matching investment yields

· Negative rates throw the entire concept of maturity matching of assets and liabilities off target, especially for banks

· Treasurers may become victims of the myth of substantially cheaper debt versus equity

· What do negative rates mean for equity investments?

· Technically falling rates are positive for equities as they reduce the cost of capital. That is not necessarily the case with negative interest rates.

· Banking stocks are the most vulnerable as they will be hit by compressing yields and also will have to pay central banks to park.

· Negative rates create an easy money scenario and hence valuations tend to be high to due to excess liquidity in the system. This creates asset bubbles in equities.

· What do negative rates mean for bond investments?

· Negative rates are a sign of the central bank’s weak outlook for economic growth.

· This typically creates a flattening of the yield curve as yields at the long end of the curve fall sharper than the short end.

· What do negative rates mean for global currencies?

· Negative rates create currency crowding. For most of last year we saw investors crowding to the US$. Normally a crowded trade creates volatility in the currency

· Negative rates are a proxy for devaluation and this has the potential to degenerate into a full-fledged currency war

· Emerging market currencies are the most vulnerable. We saw how China devalued the Yuan indirectly in August 2015 resulting in a domino effect across emerging market currencies

Global markets have not been in the grip of negative rates for such a long time in recent memory. To that extent, it is a novel experience for global markets and they will take time to adjust to the new order. With oil prices continuing to remain low, inflation unwilling to pick up and growth elusive, it looks like negative rates are here to stay. Unless, of course, the US Fed decides to embark on aggressive rate hikes which looks unlikely, at least for now!