Negative yields are seldom mentioned in economic and finance textbooks. But now that the central banks of Denmark, the eurozone, Sweden and Switzerland have set official rates below zero, investors are having to grapple with negative yields for short-dated, and indeed, some longer-maturity fixed income instruments.
Much of the stock of core European government debt outstanding recently entered negative-yield territory. This represents a new paradigm for investors in every asset class, not just fixed income.
Why would anyone buy a bond with a negative yield?
Investing in a negative-yielding bond (NYB) effectively guarantees that the bond holder will make a loss. This may seem like an irrational investment decision, but there are several reasons why investors might continue to buy bonds with negative yields. Central banks, passive fixed income funds and insurance companies have little choice but to buy the highly rated fixed income assets that may now come with negative yields, because of regulation, mandate guidelines and the need to match liabilities. There are also other rational reasons to expect demand for NYBs:
- If deflationary forces are expected to persist, buying NYBs today may still result in a positive real yield for investors.
- Investors may expect to sell NYBs for a capital gain to central banks engaged in quantitative easing.
- Similarly, investors could expect capital gains from NYBs if a central bank is expected to lower its policy rates further.
- Investors can make positive total returns if foreign-currency gains boost the return from NYBs.
- Investors demanding liquidity and safety may expect positive relative returns from NYBs during “risk-off ” episodes in markets.
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