Accentuate the negative
Why investors would opt to lose money
Jan 24th 2015
A GUARANTEED loss. That is what investing in bonds at negative yields implies: those who buy the bonds will get back less than they paid even after interest is taken into account (and some will have to pay tax on the income as well). Yet government bonds of various maturities in as many as ten countries are selling at negative yields. Why on earth would bond investors, the “masters of the universe” once famed for intimidating governments, be willing to accept such a lousy deal?
One obvious reason is fear, or at least caution. In the depths of the financial crisis in 2008, when the safety of the banks seemed in doubt, short-term Treasury bills offered negative yields and investors were happy to take them. (Holding physical cash is impractical, given the sums involved.) Now, with some uncertainty about what might happen to banks were Greece to leave the euro, investors may decide it is worth accepting a negative yield of 0.16% on two-year German bonds. “In effect you’re paying a 16-basis-point custody fee for keeping your money safe,” says David Lloyd of M&G, a fund-management group.
In other words, investors are willing to lose a little to make sure they don’t lose a lot. But it is harder to see this as an explanation for negative yields on longer-term debt, such as Switzerland’s ten-year bonds. You would have to be quite depressed to conclude that no asset on the planet would make any money at all over the next decade.
Why might investors be so gloomy? The euro zone is struggling to generate growth and faces a poor demographic outlook, with the workforce in many countries either stagnant or set to fall.
Even so, accepting a negative yield over ten years is quite a bet. Long-term bond yields are, in effect, a forecast of the future direction of short-term rates. The European Central Bank has imposed negative rates at the moment, but will rates still be below zero in a few years’ time?
Another reason investors might accept a negative nominal yield is if they expect steadily falling prices, ie deflation. In such circumstances, a negative nominal yield could still deliver a positive return in real (inflation-adjusted) terms. In the latest report, the euro zone had experienced falling prices over the previous year.
.
Deflation does not automatically lead to negative yields, however. Japan has had periods of deflation for more than a decade. While its bond yields were for a long time the lowest in the world, they only went negative recently (see chart). And most forecasts still predict a modestly positive rate of inflation in the euro zone this year.
Another possibility is that foreign investors may expect currency gains to outweigh any losses on the bond itself. International investors who bought Swiss bonds before the Swiss franc’s recent jump (it rose 30% against the euro in minutes after the central bank abandoned its exchange-rate cap and ended the day 12% higher) will have made a killing.
Believers in the theory of purchasing-power parity think that, over the long run, exchange rates adjust to account for price differentials. A country with a relatively high inflation rate will tend to see its currency depreciate; a country with a low inflation rate will see its currency rise. So international investors who expected to see the Swiss economy suffering a long period of deflation might accordingly expect the Swiss franc to rise steadily, and thus be willing to hold its government bonds.
Some banks and institutions are also forced to hold government bonds, regardless of their yield, because of regulations and liquidity requirements.
The final possibility, and the most obvious explanation in the short term, is that investors have been anticipating the introduction of quantitative easing by the European Central Bank. If experience in America and Britain is any guide, purchases by the ECB will eventually drive prices up and yields down. Why worry about the theoretical loss involved in holding a bond till maturity if the investor knows he can offload the bond to his friendly neighbourhood central bank?
There are risks involved, of course. If the global economy returns to normal, then losses on government bonds will be substantial. The same would be true if inflation ever reappears. M&G says that if German bond yields merely rose back to the levels that prevailed at their previous trough, in 2012, when it was feared the euro might break up, investors would suffer a capital loss of 7%. Whatever else European government bonds may be, they are not risk-free.
One obvious reason is fear, or at least caution. In the depths of the financial crisis in 2008, when the safety of the banks seemed in doubt, short-term Treasury bills offered negative yields and investors were happy to take them. (Holding physical cash is impractical, given the sums involved.) Now, with some uncertainty about what might happen to banks were Greece to leave the euro, investors may decide it is worth accepting a negative yield of 0.16% on two-year German bonds. “In effect you’re paying a 16-basis-point custody fee for keeping your money safe,” says David Lloyd of M&G, a fund-management group.
In other words, investors are willing to lose a little to make sure they don’t lose a lot. But it is harder to see this as an explanation for negative yields on longer-term debt, such as Switzerland’s ten-year bonds. You would have to be quite depressed to conclude that no asset on the planet would make any money at all over the next decade.
Why might investors be so gloomy? The euro zone is struggling to generate growth and faces a poor demographic outlook, with the workforce in many countries either stagnant or set to fall.
Even so, accepting a negative yield over ten years is quite a bet. Long-term bond yields are, in effect, a forecast of the future direction of short-term rates. The European Central Bank has imposed negative rates at the moment, but will rates still be below zero in a few years’ time?
Another reason investors might accept a negative nominal yield is if they expect steadily falling prices, ie deflation. In such circumstances, a negative nominal yield could still deliver a positive return in real (inflation-adjusted) terms. In the latest report, the euro zone had experienced falling prices over the previous year.
.
Deflation does not automatically lead to negative yields, however. Japan has had periods of deflation for more than a decade. While its bond yields were for a long time the lowest in the world, they only went negative recently (see chart). And most forecasts still predict a modestly positive rate of inflation in the euro zone this year.
Another possibility is that foreign investors may expect currency gains to outweigh any losses on the bond itself. International investors who bought Swiss bonds before the Swiss franc’s recent jump (it rose 30% against the euro in minutes after the central bank abandoned its exchange-rate cap and ended the day 12% higher) will have made a killing.
Believers in the theory of purchasing-power parity think that, over the long run, exchange rates adjust to account for price differentials. A country with a relatively high inflation rate will tend to see its currency depreciate; a country with a low inflation rate will see its currency rise. So international investors who expected to see the Swiss economy suffering a long period of deflation might accordingly expect the Swiss franc to rise steadily, and thus be willing to hold its government bonds.
Some banks and institutions are also forced to hold government bonds, regardless of their yield, because of regulations and liquidity requirements.
The final possibility, and the most obvious explanation in the short term, is that investors have been anticipating the introduction of quantitative easing by the European Central Bank. If experience in America and Britain is any guide, purchases by the ECB will eventually drive prices up and yields down. Why worry about the theoretical loss involved in holding a bond till maturity if the investor knows he can offload the bond to his friendly neighbourhood central bank?
There are risks involved, of course. If the global economy returns to normal, then losses on government bonds will be substantial. The same would be true if inflation ever reappears. M&G says that if German bond yields merely rose back to the levels that prevailed at their previous trough, in 2012, when it was feared the euro might break up, investors would suffer a capital loss of 7%. Whatever else European government bonds may be, they are not risk-free.
0 comments:
Publicar un comentario