Buying into the near–$17 trillion heap of global bonds with negative yields might sound like a losing proposition. But for some investors — those who predicted correctly that bond prices this year would climb amid worries about sluggish global growth — negative yields actually have been a cash cow.
“There is a big misunderstanding about negative-yielding debt,” said James Bianco, founder of Bianco Research, in an interview with MarketWatch. “Owners of these bonds have been seeing huge price increases.”
With bond prices moving in the opposite direction of yields, the sharp yield decline this summer, as the U.S.-China trade war has raged and American recession fears have bubbled up, has put significant price gains on the table.
Take Austria’s 100-year bond, which has seen its yield to maturity plunge to below 1% in recent weeks.
The European country set a record two years ago when it borrowed €3.5 billion for a century in the international bond markets at a yield to maturity of 2.1%, according to the Financial Times. But this chart shows the yield to maturity shrinking to just 0.71% as of Aug. 20, as demand (and the security’s price) has climbed:
As a result, investors in Austria’s century bond at par, or 100 cents on the euro, roughly two years ago at issuance, could have sold in August when the price briefly soared above 200 cents, for a more than 100% return.
The flip side to this “upside-down, anything is possible” world of negative-yielding bonds that fetch “astronomical prices,” according to Bianco, is that bonds are only required to be repaid at par by the issuer when they mature. “When you’re paying more above par than the sum of all coupons, that is how you get to negative yields,” he said. “At some point that will blow up, but it hasn’t yet.”
The culprit? Demand for government debt that’s been climbing along with expectations that weakening eurozone economies would eventually force the European Central Bank to restart its asset-buying program to bolster the bloc’s economies.
Last week, a member of the ECB’s rate-setting committee said the market could expect fresh stimulus that should include “significant and sufficient” bond purchases and cuts to key interest rates to be announced in September.
Bloomberg on Thursday reported that Germany’s central bank doesn’t currently see a need for fiscal stimulus, because Europe’s biggest economy is in a period of long stagnation but not a recession.
But even ahead of recent hints at more ECB bond buying, investors have been snapping up riskier assets beyond sovereign debt that, if held to maturity, would result in subzero yields.
Specifically, the past few weeks have seen the universe of negative-yielding corporate bonds more than double to $1.2 trillion.
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Deutsche Bank’s chief economist, Torsten Sløk, said in a Wednesday note to clients that the hunt for positive returns has pushed European money managers and Japanese banks into debt issued by the U.S. Treasury and American businesses.
Concerns have been raised about unfettered borrowing in both parts of the market.
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But as Sløk also pointed out, it has been hard for investors to avoid U.S. corporate debt because it now makes up 50% of all global investment-grade corporate bonds.
“This virtuous cycle for U.S. assets continues until the day when the U.S. enters a recession,” Sløk warned. “Then corporate default rates will move up and earnings growth will slow down.”
Meanwhile, demand for longer-term Treasury debt also has set recent records.
This chart shows returns on Treasury debt that matures in more than a decade topped 20% for the first time ever on Aug. 20, or at least since the Merrill Lynch 10+ Year U.S. Treasury Index started tracking the data in 1987.
That puts those longer-term bond gains ahead of the pace of the S&P 500 index SPX, +0.03% , which as of Thursday was up about 17% thus far in 2019.
U.S. stocks were mixed Thursday, after the yield curve again inverted and weaker data emerged on U.S. manufacturing, offsetting gains in earlier trade, and with a pair of Federal Reserve officials saying at the central bank’s annual Jackson Hole, Wyo., summit that further interest-rate reductions might not be in the cards.
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