Why do global investors keep buying bonds with negative yields
BUYING NEGATIVE-YIELD bonds is a conundrum from the point of view of investors.
However, the number of negative-yield securities seems to be expanding, not shrinking. Recently, Japanese government bonds that will mature in 10 years joined the negative-yield group, offering minus-0.04 per cent a year.
To provide some context of fixed-income securities in brief, a bond is a contractual commitment made by a borrower to pay the debt, equal to the bond’s face value, together with interest, also known as coupon, to bondholders.
The face value of the bond and the coupon are generally fixed at its origination date. Investors buy or sell a bond at market price.
The “yield” or return that investors receive from the bond is calculated by dividing the sum of future cash flows they would get from the bond by the purchased price.
In layman’s terms, “higher yield” means higher profit. That is why most investors seek high and stable yields.
Back to our main story: What does “negative yield” mean?
It means investors purchase a bond with its market price already exceeding the sum of future cash flows that they can get from it.
For example, the selling price of a Japanese government bond that will mature in December 2025 is 103.37 yen, where the whole coupon plus its face value upon maturity are just 102.67 yen.
There are some rationales behind this. First, capital preservation could be the investor’s objective.
Since the beginning of this year, most equities have dropped in value by at least 10 per cent compared with a year earlier. Commodities have also fallen in price.
The default rates on corporate bonds are rising and holding money with central banks in the euro zone, Denmark, Japan and Sweden also receive negative returns.
Therefore, buying a government bond, a risk-free asset, seems to be a reasonable choice and negative yield is just a small safekeeping cost compared with a bigger loss elsewhere.
Capital appreciation is another benefit that investors are able to get through buying a negative-yield bond.
Remember the properties of bonds?
Negative yield just means that you buy a bond that is priced higher than what you will get from its future cash flow, but it does not mean that the market price cannot increase.
Many people in the financial market will keep on buying as long as they believe that central bankers will lower their reference rates further into negative territory.
In addition, foreign investors might also want to own the bonds if they think the nominated currency is going to rise. A big currency gain would be more than enough to offset the negative yield.
The last reason that attracts people to negative-yield bonds is their relative value across markets in different countries.
In the financial markets, negative-yield bonds in some countries are far better than positive-yield bonds in other countries on a relative basis.
Thailand and Japan exhibit a very good example.
Currently, if you buy Japanese government bonds that will mature in five years and swap all the future cash flows in yen to baht, you will get a pick-up in baht yield of around 40-50 basis points compared with buying Thai government bonds with the same tenor.
How does this happen?
It occurs because there more yen are printed every day because of quantitative easing. With a negative deposit rate in Tokyo, this QE increases demand for swapping the yen into other currencies to invest elsewhere.
As a result, borrowing a non-yen currency in Tokyo is somewhat more expensive than borrowing the same currency and amount in Bangkok, and the market therefore adjusts to give an incentive to those who dare to become a contrarian.
Those reasons are more than enough to support the idea of buying negative-yield bonds.
In the modern market situation, negative interest rates are just uncommon, while negative yield is undoubtedly still rare.
Nevertheless, the two developments are not so unusual.
To me, the most mysterious thing, if it happened, would be a fixed negative-coupon bond, which I don’t think is reasonable.
However, nobody knows exactly what the future may hold.
We might see every negative thing soon if the period of deflation and slow growth stays with us long enough to increase the default rate and most people have to find a safe haven to protect their capital.
Views expressed in this article are those of the author and not necessarily of TMB Bank or its executives. Jitipol Puksamatanan is global economist and currency strategist at TMB Analytics. He can be reached at [email protected].
