Economic twilight zone: Bonds that charge you for lending
BY DAVID McHUGH and PAUL WISEMANyesterday
FRANKFURT, Germany (AP) — Imagine lending money to someone and having to pay for the privilege of doing so. Or being asked to invest and informed of how much money you’ll lose.
Sounds absurd, but increasingly that’s the global bond market these days. A rising share of government and corporate bonds are trading at negative interest yields — a financial twilight zone that took hold after the financial crisis and has accelerated on fear that a fragile global economy will be further damaged by the U.S.-China trade war.
On Wednesday, for the first time ever, the German government sold 30-year bonds at a negative interest rate. The bonds pay no coupon interest at all. Yet bidders at the auction were willing to pay more than the face value they would receive back when the bonds mature.
The sale added to the mountain of negative-yielding bonds around the world that investors have gobbled up, suggesting that they expect global growth and inflation to remain subpar for years to come. After all, accepting a negative yield on a bond — agreeing, in effect, to lose money in exchange for parking money in a safe place — could reflect expectations that yields will sink even further into negative territory.
“You’re essentially paying a warehouse fee by paying these negative rates,” said Jim Bianco of Bianco Research in Chicago.“This is like a temperature gauge for the economy, and it says the economy is sick,” said Sung Won Sohn, business economist at Loyola Marymount University in California.
Despite its strong credit rating and demand for its bonds, Germany is a big part of the growth problem for the eurozone. The German economy shrank 0.1 percent in the second quarter and could tip into recession with another quarter of falling output.
Negative rates aren’t just an indicator of economic distress. They can cause problems in the financial system, too. They make it harder for banks to turn a profit or for insurance companies to fund their future payouts.
Economists and such outside voices as the U.S Treasury and the International Monetary Fund say Germany could support growth at home and abroad by spending more. Germany’s economy shrank 0.1% in the second quarter, held back by slowing global trade and the auto industry’s adjustment to tough emissions standards and new technologies.
A little bond math helps to understand things. Bond yields and prices move in opposite directions. If investors think inflation and interest rates will rise above levels now reflected in bond yields, they may sell the bond, sending its yield higher. Conversely, demand for bonds — as seen now — drives the price up and the yield down. The more investors foresee low growth and low inflation ahead, the more willing they become to buy bonds that offer low returns. They can earn healthy returns from rising bond prices, even when the yields are negative.
One big reason for falling yields is purchases by central banks. The European Central Bank bought 2.6 trillion euros in government and corporate bonds as part of a stimulus program that ended in December. As the economic picture has worsened, the bank has signaled those purchases might start again.
In addition to its signal about the economy, negative yields can make it harder to fund retirement savings. The high bond prices reflected in the low yields also raise the possibility of a bond market plunge if sentiment changes.
That could happen if the economies of Europe and Japan begin to regain momentum and their central banks call off their easy money policies.
“The worst thing that can happen for these bonds is, God forbid, the economies recover,” Bianco said
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