These Strange Days: $10 Trillion in Negative Yields

It has been a remarkable few days in the global bond markets. The Financial Times as well as the Wall Street Journal reported that there is now $10 trillion worth of sovereign debt with negative yields. In the last few days, the German 10-year bund has hit a low of 0.3%, seemingly on its way into negative territory. In the U.S., the 10–year yields have fallen in concert, pulled ineluctably lower by the gravitational pull of overseas bond markets. At their last auction 10-year yields were 1.67%. Further, the recent weak jobs report has pushed the expectation of the next U.S. interest increase farther out on the calendar. In the short term, the U.S. Fed is not a countervailing force against falling yields.

The significance of negative yields is truly hard to fathom. All the future value of the debt instrument is being realized in the present – there is no future value. This has tremendous repercussions for the business models of industries such as insurance or pension funds. It becomes difficult to match future long-term liabilities if today’s assets have no return. Yet, these institutional buyers are forced to continue buying securities. And seemingly the only justification that one can put forward to buy these negative yielding assets is that yields will fall further. It is a variation on the “Greater Fool Theory” (I will foolishly buy this overvalued asset counting on a greater fool to buy it from me at an even higher price).

Part of the recent strength in the equity markets can be attributable to the search for yield. Investors are purchasing stocks with dividend yields greater than 10 year Treasuries. The S&P 500 yields 2.2% versus 1.7% on the 10-year. The CFOs of companies can capture a positive spread by buying back stock financed by debt that yields less than the stock.

There is a Wall Street maxim attributed to John Maynard Keynes that the market can remain irrational far longer than an investor can remain solvent. Over the last couple years, those who have been betting that yields would rise have lost money. And remember, the “smart” money was positioned for a rising rate environment in 2016. However, at some point, unless we are in a deflationary environment, losses in the fixed income market are going to be realized. Those holding negative interest-rate bonds will realize a loss as those bonds mature. If rates were ever to increase, those losses would be realized much sooner.

Of course, while this author should be able to pronounce with some confidence that there will be losses in the fixed income market, Japan represents the counter argument. Its yields have been lower for longer than anyone could have imagined possible. And not only have they been lower for longer, but now they have slid into negative territory. Perhaps we are not appreciating the cumulative force of aging societies, deflation and slow economic growth across the globe. Nonetheless, I maintain that we will tell our grandchildren of these strange days where interest rates were negative.