bonds / interest / investing

The least dirty shirt in the laundry: Negative bond yields

 Well, we aren’t there yet (negative interest rates) but anyone with a savings account or looking a bond yields lately (or listening to Federal Reserve Bank Chair Jerome Powell) knows that rates are falling fast. 

Many European countries are issuing bonds with NEGATIVE interest rates, meaning that the investor pays the bond issuer a fee to keep their money safe. It’s a strange concept when we are used to getting paid by the issuer for the use of our money. 

Why would anyone pay someone to hold their money rather than put it under the proverbial mattress? Why get back at some date in the future less than you invested?

There are $16 trillion of bonds world-wide paying negative interest rates!

Simon Constable, writing for The Wall Street Journal (10/5/20) explains 5 reasons:

1. The bond offers security (at a cost). Think of the negative yield as the storage fee, the cost of security that you will get your money back (less a fee) in the future. Some U.K. banks already are charging savings-deposit customers a negative yield.

2. The chance of a quick trading profit. traders are willing to accept a negative yield if they expect rates to dive lower in the future. they could profit by selling the initial bond at a premium. 

3. When expected currency moves will likely offset the negative yields. This applies to international investors. However, “forecasting future currency movements is notoriously tricky.” Not for the faint of heart.

4. When the bond is still safe, relatively speaking. “During the 2008-2009 financial crisis, investors often described the U.S. as the least dirty shirt in the laundry basket, meaning that while the U.S. wasn’t in great shape, other countries were in worse condition.” The same concept applies today with regard to negative interest rates. What options do you have? Lots of money is flowing into U.S. stocks because bond yields are so low, which explains why the stock markets seem to be ignoring the world-wide coronavirus pandemic. 

5. Purchasing power is maintained. The main reason investors would invest in negative yields is during times of deflation (a sustained drop in prices of goods and services). If prices drop faster than the negative yield, one has more purchasing power.  “If your purchasing power grows over the investment period, it doesn’t matter how negative the yield is on the bond.” 

This article was followed in the WSJ on 10/9/20 with “Savers face limited option” by Julia Carpenter. Interest rates on savings accounts (including online accounts) are plunging with few options. “Looking for more yield, however, often means taking on more risk and sacrificing liquidity.” Some options are money market funds (still low yields) and some fixed-income exchange-traded funds offering 1-2%. 

Just more dirty laundry!

Source: Financial Planning for Women