The Logic Behind the Bonds That Eat Your Money

By John Ainger

July 25, 2019, 12:01 AM EDT

One of the basic assumptions of debt is that borrowers pay interest to lenders. That idea has been upended in the global bond market. There’s now about $13 trillion in negative-yielding bonds. Investors who hold them to maturity will end up getting less money than they paid for them, even including interest.

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Illustration: 731

The prevalence of negative yields pulls down the rates on all kinds of debt—including riskier loans—creating a bonanza for borrowers and some pain for lenders and savers. Yet these less-than-zero rates are largely a symptom of deeper problems in the economy.

Negative-yielding bonds make up about a quarter of the investment-grade debt tracked by the Bloomberg Barclays Global-Aggregate Index. Investors have to pay to own more than 80% of Germany’s federal and regional government bonds; almost the entire Danish government market is negative. The U.S. is one of a dwindling number of nations with no negative-yielding sovereign debt.

Negative-Yielding Debt by Country

Americas
Europe
Asia
Other regions

Total:

Americas

Canada
Mexico
U.S.

Europe

Austria
Belgium
Bulgaria
Switzerland
Czech Republic
Germany
Denmark
Spain
Finland
France
U.K.
Ireland
Iceland
Italy
Liechtenstein
Lithuania
Luxembourg
Latvia
Malta
Netherlands
Norway
Poland
Portugal
Romania
Sweden
Slovenia
Slovakia

Asia

UAE
China
Cyprus
Japan
South Korea
Singapore

Other

Australia
New Zealand
International organizations
South Africa

How can a bond have a negative yield? It starts when an investor buys a bond for more than its face value. If the total amount of interest the bond pays over its remaining lifetime is less than the premium the investor paid for the bond, the investor loses money and the bond is considered to have a negative yield.

Data: Bundesrepublik Deutschland ‒ Finanzagentur

Photo illustration by 731. Getty Images (4)

Investors are willing to pay a premium—and ultimately take a loss—because they need the reliability and liquidity that government and high-quality corporate bonds provide. Large investors such as pension funds, insurers, and financial institutions may have few other safe places to store their wealth.

Monetary authorities have brought down bond yields by keeping key interest rates exceptionally low since the financial crisis, with the aim of spurring borrowing that would lead to economic growth. After the ECB cut its deposit rate below zero in 2014—central banks are able to actually charge banks to hold their money—several of Europe’s other monetary authorities also introduced negative rates. The Bank of Japan soon followed, although it was already a trailblazer when it adopted zero interest rates two decades ago. Central banks also helped push rates down by embarking on purchases of longer-term debt, in what became known as quantitative easing.

Central bankers are reacting to broader economic forces. One reason they typically raise rates is to curb inflation. But prices haven’t been shooting upward, and gauges of the market’s inflation expectations show there’s little on the horizon. Particularly in Japan, persistent fears of deflation—falling prices—can make negative yields seem like a reasonable deal.

Inflation generally goes hand in hand with a strong economy. While central bankers have been trying to stimulate growth, some governments have been more conservative. Take Germany: Even though the bond market is willing to pay the country to borrow, the government has been reluctant to jeopardize its budget surplus.

One theory is that demographic forces will keep inflation and rates permanently low. Europe is thought to be going through a process that’s already played out in Japan—as populations get older and the share of working-age people falls, there may be too little consumer demand pushing prices up. Meanwhile, pension funds are willing to pay up for long-dated bonds—and accept low yields—to match their increased retirement liabilities.

Ultralow rates on the safest bonds has had a spillover effect on other markets. A handful of corporate junk bonds denominated in euros have negative yields. Investors are bidding up the prices of all kinds of riskier assets—from equities to emerging-market bonds—in search of better returns. “It’s a huge question and dilemma for savers,” says Andrew Bosomworth, head of portfolio management in Germany for Pimco.

On the flip side, most banks in Europe haven’t been able to pass negative rates onto their depositors, squeezing interest margins. Advocates of negative rates argue that they nonetheless have helped boost overall bank earnings by underpinning economic growth. But major European lenders say further rate declines will cut into their profitability. Deutsche Bank’s finance chief James von Moltke told Bloomberg Television on July 24 that lower rates pose “a significant risk to us.”

The U.S. has never had negative rates on conventional Treasuries, but it’s come close. Two-year yields touched 0.14% in 2011 and stayed very low until the Federal Reserve started hiking rates at the end of 2015. Now, amid worries about the economy, the Fed is expected to go back to cutting rates this month.

With 10-year Treasuries paying about 2%, negative seems a long way off—the price of the bond would have to rise about 20%. But the minus sign has become so commonplace in so much of the world, nothing seems impossible. Says Scott Thiel, chief fixed-income strategist at BlackRock Inc.: “There’s no chapter in your bond math book on this.”

The Logic Behind the Bonds That Eat Your Money

Negative-Yielding Debt by Country

How to Get a Negative Yield