The Black Hole Engulfing the World’s Bond Markets

1. How can a bond have a negative yield?

The path to a negative yield typically starts when an investor buys a bond for more than its face . If the total amount of interest the bond pays over its remaining life 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.

2. Why invest in a bond that will lose you money?

Typically, bonds are the safest assets on the market, so many investors seek them out at times of heightened market stress -- during a pandemic scare, for instance. A bond can have a modestly positive coupon when issued by a government, institution or company, but high demand by investors can push its price up -- and therefore its yield down. Some funds must buy the bonds regardless of their yield because they are duty-bound to track government bond indexes. And some investors can still make positive returns on these bonds when adjusted for currency swings.

3. How much is being bought?

While negative-yielding debt has retreated from its $17 trillion peak in August 2019, it’s on the way back up as central banks around the world embark on more rate cuts. About 25% of global investment-grade debt is under water. That includes all of Germany’s government bonds, which is why investors effectively pay the German government 0.7% for the privilege of buying its benchmark bonds. None of the U.S.’s $16 trillion government debt pile yields less than zero, but that privileged position looks under threat amid the spread of the coronavirus. Ditto for Australia.

4. Why is this reason for worry?

Negative rates are at odds with basic principles of the global finance system. “One important law of financial logic –- if you lend money for longer, you should see a higher return –- has been broken,” wrote Marcus Ashworth, a Bloomberg Opinion columnist covering European markets. “The time of money has essentially disappeared.” (Has it ever: The so-called century bonds issued by Austria two years ago, which mature in 2117 and initially offered a 2.1% return, now yield about 0.5%.) All this can push investors into riskier bets in the hunt for returns, raising the chances of bubbles in financial markets and real estate.

5. Who benefits from negative rates?

Governments, for one. The incentive to borrow money is never greater than when you are being paid to do so. Germany, for example, is being subsidized to issue debt over the next 20 years, though that does not necessarily mean it will boost spending. Companies that issue bonds also reap the benefits of record-low borrowing costs. So do private-equity firms, which typically use leverage to acquire companies and see greater opportunities when (and where) capital is cheap. Homeowners with variable-rate mortgages also have reason to celebrate.

6. Who gets hurt?

Pension funds and insurers, traditionally big investors in government bonds, are in a particular predicament: Their liabilities grow steadily as clients age, but often they are required not to take on big risks. Banks see their margins squeezed. They’re earning next to nothing from lending but still need to offer depositors a rate above zero to keep their business. In Germany, the European Central Bank has come under political pressure for hurting the returns of savers. Central banks could run into the problem of hitting the so-called “reversal rate” -- the point at which low borrowing costs start to harm rather than help the economy, should banks start to restrict loans. That could deepen any slowdown.

7. How did we get here?

Several of Europe’s central banks, otherwise unable to spur growth in the aftermath of the 2008-2009 financial crisis, cut interest rates below zero in 2014. Japan soon followed. The idea was to spur lending by charging financial institutions, rather than rewarding them, for parking money that otherwise could be put to use in the real economy. Since 2016, the ECB’s benchmark rate has been -0.5%, meaning banks lose 5 euros to store 1,000 euros there. The sub-zero rates were supposed to be temporary but have endured. After the Fed cut rates by 50 basis points in an emergency move to combat the economic fallout from the coronavirus, traders are betting that the ECB and the Bank of England will soon follow suit, driving record levels of bond yields below zero.

8. Why have negative rates lasted so long?

More than a decade on from the credit crisis, inflation is still scarce, with wages increasing only modestly despite large drops in unemployment. The ECB, for example, isn’t expected to get to its close-to-2% inflation target over the next decade, according to a market-derived measure. And the yield difference between U.S. three-month bills and 10-year Treasuries is inverted, an indication that an economic contraction may be coming. Aside from the U.S. Federal Reserve, few central banks that slashed interest rates during the credit crunch have managed to raise rates, meaning that during the next downturn they are likely to head further into negative territory.

9. Where’s all this heading?

In Europe, there are fears that the continent is following the path of Japan’s so-called lost decade, where policy makers struggled to revive anemic growth and inflation. Central banks have been keen to iterate that they still have tools in their locker to combat any slowdown, including rate cuts and more quantitative easing. Geopolitical tensions over trade, Britain’s trade negotiations with the European Union and the coronavirus will keep driving investors into the safest assets, meaning demand will remain high for negative-yielding debt. But the push to find juicier returns with riskier bets raises the prospect of further fund failures or a new crisis.

The Reference Shelf

• Stories on U.S. Treasury yields hurtling toward zero and German bond yields reaching record lows.
• The logic behind the bonds that eat your money.
• Why buyers of negative-yielding debt aren’t necessarily fools.
• QuickTakes on negative interest rates, yield curve inversion and central bank independence.
• Bloomberg Opinion columnist Marcus Ashworth delved into the implications of “this tectonic shift in fixed income.”
• The crisis at Danske Bank illustrates the full extent of damage from negative rates.
• An ECB paper on negative rates not being unproductive once they reach the zero lower bound.
• The scourge of Japanification is threatening to go global in 2020.

©2020 Bloomberg L.P.