NEGATIVE YIELD BONDS
Negative yield bond refers to a situation in which debt issuers are paid to borrow. At the same time, depositors or bondholders pay cash instead of collecting interest income. In a negative-yielding bond, the investors lose money at maturity. Negative-yielding bonds are usually purchased as safe-haven assets in times of turmoil and by pension and hedge fund managers for asset allocation.
In 2019, the amount of negative-yielding bonds in the global market was $13 trillion. In 2016, almost 30% of the global government bond market and some corporate bonds, traded negatively. Creditors, such as central banks, insurance firms, and pension funds, are interested in such low-yielding bonds. This is to satisfy their liquidity needs, and they can also be pledged while borrowing.
Investors sometimes feel that they can make money with negative returns. For example, foreign investors may assume that the currency would increase, which would offset negative bond yields. Domestic investors look out for deflation in which they could make money by using their savings to purchase more goods and services.
Even China sold negative-yield debt for the first time, and this saw a high demand from investors across Europe. As yields in Europe are even lower, there was a huge demand for the bonds issued by China. China’s 5-year bond was priced with a yield of –0.152%, and the 10-year and 15-year securities with yields of 0.318% and 0.664% respectively.When countries put in negative interest rates, it contributes to the production of government bonds with sub-zero yields. Investors still purchase these bonds as they have good liquidity, and few options are safer than government bonds.
Individuals invested in ETFs or mutual funds that track an index may end up owning some negative-yielding bonds as part of a broader basket designed to mimic the exposure of a particular market or geographic region. The U.S. may not be accustomed to negative yielding bonds, but they are prevalent across Japan and Europe. In these places central banks own 21% and 48% of their own outstanding government debt, respectively. Unorthodox monetary policy in Europe and Japan, including the cutting of interest rates into negative territory and aggressive asset purchase schemes, resulted in negative-yielding debt across the yield curve. In 2014, the European Central Bank (ECB) was the first major central bank to lower a key interest rate into negative territory. Essentially, the goal was to stimulate economic growth by lowering the cost of debt to stimulate borrowing. Simultaneously, banks were penalized for holding too much cash at negative rates. If more fixed-income securities are low-yielding, the returns provided by bonds will begin to reach the negative territory. Some investors are, therefore, buying bonds with negative returns because they believe that future bonds will offer even worse returns.
In 2020, the Federal Reserve stepped in to support the economy during the Covid-19 pandemic by setting the target Federal Funds rate to zero. While it is widely believed that the Federal Reserve would not follow the European Central Bank in setting below zero target rates, that does not mean bond yields cannot go negative. When demand raises prices, yields go down.
The proportion of bonds carrying negative yields fell sharply in the first half of 2021 on the back of rising market rates. As of 30 June 2021, the combined nominal value of Dutch bonds with negative yields totalled €624 billion, down €142 billion on 31 December 2020. It had previously climbed to a €795 billion all-time high in November 2020, but has receded 22% since then.
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