One of the most curious developments of the global economic malaise has been the rise of negative yielding bonds – investments that actually lose money. For the first time in recent history, all of the bonds that have been issued by the Swiss government currently "boast" a guaranteed loss for the investor.
The current low interest rate era has already driven down the interest (or coupon) payments being offered by bond issuers. But the forces driving bonds into negative yields is somewhat counterintuitive – it is because demand for bonds is so strong that it outstrips supply.
That means investors are willing to buy bonds at above their face value. When the price inflates so far above face value that it is not covered by the remaining coupon payments, the yield goes into the red and buyers lose money on their investment.
The market has been driven into overdrive by central banks, such as the European Central Bank (ECB), buying up bonds in the hope of stimulating the economy and by the flight of investors to safe haven currencies, such as the Swiss franc.
“The ECB is currently gobbling up government bonds, and even moving into corporate bonds. This action is artificially inflating demand for bonds, driving up their price and decreasing yields,” explains Julius Bär chief economist Janwillem Acket.
Given the terrible returns being offered by bonds, it seems remarkable that the market is booming. A good deal of the demand is being artificially generated by the ECB and other central banks, but there are other investors willing to take a loss.
Institutional investors such as banks, insurers and pension funds are obliged to hold bonds as part of their reserves for various reasons.
Another group of bond buyers are investors who move into strong currencies, such as the franc, hoping to recoup their losses – and even make a profit – from exchange rates.
And then there are the ultra-cautious investors looking to put some of their wealth into a safe investment that is backed by governments, local authorities or big companies. These investors are
willing to take a hit to escape potentially bigger losses to be found elsewhere in the volatile markets.
Julius Bär believes negative bond yields will be around for several months to come, probably not returning to positive territory for the best part of a year. For Acket, the only cure is for the global economy to return to a path of sustainable growth, probably led by a resurgent United States.
Would you still invest in Swiss government bonds, given the yields? Tell us in the comments.