7 ms·

For those wondering why anyone would buy such a thing, consider: - Many financial institutions are required to hold a certain percent of portfolio in safe asse

by apo 7y ago

For those wondering why anyone would buy such a thing, consider: - Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world. - A holder of a bond earns a capital gain (bond goes up in price) when interest rates fall. In that sense, zero is no limit at all because there can always be a buyer willing to accept an even lower (more negative) yield. - Bond investors are well-aware of the two points above. When they sense that interest rates and/or inflation are headed lower, they know they can profit by buying, regardless of yield. - Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years. - The European Central Bank has repeatedly signaled its belief that zero is no barrier and that negative yields will be tolerated indefinitely. The ECB stands ready for quantitative easing (QE), in which the central bank buys bonds with money it creates from thin air. Investors know this and this compounds the incentive to pile on and buy bonds to enjoy the capital gains (and real returns if the investor believes that deflation is inevitable). It's likely that all these factors combine to create the current environment. How long all of this can continue is anybody's guess because the situation is without precedent. It's as if the financial crisis of 2008 was never resolved - just papered over through massive central bank purchases of treasuries and stocks (Japan's central bank owns a major fraction of the value of the Japanese stock market at this point).

whatok 7y ago
Good post that covers nearly everything. The only thing I would add to this is that the ECB's deposit rate of -0.40% is the only thing that has enabled all of this.
- AdrianB1 7y ago
  Actually the ability of the ECB to print money out of nothing is the main enabler.
  - arez 7y ago
    isn't that the it's job? It hands out loans for money it doesn't have but can steer the market with the interest rates
  - whatok 7y ago
    The ECB printing money is a factor in stabilizing rates but it in itself does not create conditions where governments are able to borrow for 30 years at negative rates. For example, if the deposit rate was at 3.00% instead of -0.40%, governments would not be able to issue at negative yields; QE or no QE. Additionally, the ECB stopped net QE purchases at the beginning of the year and negative rates are still a thing.
- wcoenen 7y ago
  This would explain negative bond rates down to -0.40%. Because if you need to park a very large amount of euros safely, banks will start to apply that rate to your deposits so it's better to get any rate that is less negative. But curiously 10y german bund yields have recently hit -0.70%, and a couple other EU countries (France, Netherlands, Belgium) have also dipped below -0.40%. So it must be more than the negative deposit rate. It's also the QE program which buys bonds (though it's on hold since the start of the year), and the expectation of lower deposit rates, and the expectation of more QE.
  - whatok 7y ago
    I agree with all of this and probably could have phrased my original post better. My main point is that none of this is really possible without ECB rates being set where they are. Successful monetary policy requires multiple tools to be utilized and the deposit rate is the main tool that anchors everything else. QE in itself does not mean rates are going to be lower. You need central bank rates to also be low in order to have lower government rates. Rates didn't suddenly skyrocket after the ECB announced the end of QE.
    - wcoenen 7y ago
      > Rates didn't suddenly skyrocket after the ECB announced the end of QE. That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought. I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money.
      - whatok 7y ago
        > That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought. Reinvesting maturing proceeds does not produce the same effect as net purchases. One, maturities are lumpy vs regularly scheduled net purchases. There have been rate shocks where idiosyncratic country events happened outside of maturities. Two, while the ECB can basically do whatever it wants, no new net purchases restricts its ability to act in an emergency. Three, size is much smaller. >I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money. Note how I didn't mention anything about negative rates in particular; just low rates and that the deposit rate anchors things. Whether rates are negative or not really doesn't matter in isolation. What matters is the spread vs other less risky assets for the goals of the central bank. If a central bank indiscriminately purchases bonds without regard for existing yields or the deposit rate, they will quickly lose control over the market.
logicallee 7y ago
>- Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world. Can you explain how this can possibly beat cash? If I say to you "I'll let you pay me ten cents to hold onto your $100 bill for a while, and give you a paper showing the obligation to repay your $100" (the meaning of a negative yield bond), how can the offer to let you pay ten cents to let me hold your $100 possibly be less risky than just holding the $100? Why would a bond with a negative yield ever be a safer asset than just holding the cash?
- deleted 7y ago
  [deleted]
- blawson 7y ago
  Maybe at certain sums much larger than individual depositors concern themselves with, you can't just "hold the cash". Like banks might say there is no way we want your $10 billion in cash to look after. Either invest it yourself or pay us to invest it for you.
  - josefx 7y ago
    You really don't want $10 billion in a bank. Laws mostly guarantee a few hundred thousand per account holder if the bank itself has financial issues. You would have to spread that amount over quite a few banks if you wanted it secured.
- auntienomen 7y ago
  The world is different when you're dealing with really large amounts of cash. You can't just store it yourself; your mattress isn't big enough. And if you ask a bank to store it for you, the bank will charge you for the service. (Banks that work in this line of business are known as 'custodian banks'.) Consequently, the effective interest rate on cash for large amounts of cash can be negative.
- whatok 7y ago
  You can argue safety (bonds you have sovereign default risk vs cash will have bank credit risk) but your math is not incorporating how a transaction in this case would actually take place. It's not as simple as just holding onto $100. You have a deposit rate of -0.40% at the ECB. So instead of -0.40%, you settle for -0.14% which is what these newly issued Bunds are yielding.
shpongled 7y ago
Also, you can sell or buy bonds at any time - you're not locked in for 30 years. I think this is a crucial point many don't understand
simonebrunozzi 7y ago
Great comment, however: > the central bank buys bonds with money it creates from thin air QE generates inflation in the long run, which would by definition make these bonds less valuable over time.
solatic 7y ago
> - Many financial institutions are required to hold a certain percent of portfolio in safe assets. In practice this is turning into unnatural demand guaranteed by the law, which goes against free markets and will eventually implode upon itself. If you force the market to buy a certain product regardless of quality, then the underlying quality of that product will erode (as there is no longer an incentive to provide quality and quality implies cost), and the market will evaporate as stakeholders disappear and move to other markets which do assure real quality. That there was natural demand for such products in the past, and indeed that natural demand may coincide with unnatural demand in the present, is not a guarantor for demand levels staying natural in the future. In context, this creates underlying pressure for investors to divest from Euro holdings. It's likely that investors are currently sticking with the Euro because they have few other avenues for escape, but this is not likely to hold - whether due to Brexit/Euroskepticism or some other external crisis which changes the playing field.
- landivar2 7y ago
  When you have a central bank that can control rates, no alternative money, and the bank can set rates negative, the equilibrium is for the government to own almost all assets. I'm not kidding. You will end up with communism, only via government regulation of rates, unless something breaks this up.
  - kthejoker2 7y ago
    If our capital markets are so unproductive that having the government own the assets is considered a net economic gain, we'll need all the communism we can get. The central bank does not "control" rates, they respond to the market signaling where rates should be.
dvfjsdhgfv 7y ago
> - Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years. But for this and the other reasons you mention, wouldn't cash be in any case better than the bonds?

by apo 7y ago

whatok 7y ago

Good post that covers nearly everything. The only thing I would add to this is that the ECB's deposit rate of -0.40% is the only thing that has enabled all of this.

AdrianB1 7y ago
Actually the ability of the ECB to print money out of nothing is the main enabler.
- arez 7y ago
  isn't that the it's job? It hands out loans for money it doesn't have but can steer the market with the interest rates
- whatok 7y ago
  The ECB printing money is a factor in stabilizing rates but it in itself does not create conditions where governments are able to borrow for 30 years at negative rates. For example, if the deposit rate was at 3.00% instead of -0.40%, governments would not be able to issue at negative yields; QE or no QE. Additionally, the ECB stopped net QE purchases at the beginning of the year and negative rates are still a thing.
wcoenen 7y ago
This would explain negative bond rates down to -0.40%. Because if you need to park a very large amount of euros safely, banks will start to apply that rate to your deposits so it's better to get any rate that is less negative. But curiously 10y german bund yields have recently hit -0.70%, and a couple other EU countries (France, Netherlands, Belgium) have also dipped below -0.40%. So it must be more than the negative deposit rate. It's also the QE program which buys bonds (though it's on hold since the start of the year), and the expectation of lower deposit rates, and the expectation of more QE.
- whatok 7y ago
  I agree with all of this and probably could have phrased my original post better. My main point is that none of this is really possible without ECB rates being set where they are. Successful monetary policy requires multiple tools to be utilized and the deposit rate is the main tool that anchors everything else. QE in itself does not mean rates are going to be lower. You need central bank rates to also be low in order to have lower government rates. Rates didn't suddenly skyrocket after the ECB announced the end of QE.
  - wcoenen 7y ago
    > Rates didn't suddenly skyrocket after the ECB announced the end of QE. That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought. I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money.
    - whatok 7y ago
      > That's because the QE program only stopped increasing the ECB's assets. When bonds that are held by the ECB mature, the equivalent amount in new bonds is still being re-bought. Reinvesting maturing proceeds does not produce the same effect as net purchases. One, maturities are lumpy vs regularly scheduled net purchases. There have been rate shocks where idiosyncratic country events happened outside of maturities. Two, while the ECB can basically do whatever it wants, no new net purchases restricts its ability to act in an emergency. Three, size is much smaller. >I don't think negative deposit rates are really needed to have negative bond yields. You only need a bond buyer (e.g. the QE program) who drives up bond prices beyond the face value + all coupons. Negative interest rates were just a natural step in the progression of lower rates, zero rates, negative rates, and QE. The next thing will be some form of helicopter money. Note how I didn't mention anything about negative rates in particular; just low rates and that the deposit rate anchors things. Whether rates are negative or not really doesn't matter in isolation. What matters is the spread vs other less risky assets for the goals of the central bank. If a central bank indiscriminately purchases bonds without regard for existing yields or the deposit rate, they will quickly lose control over the market.

logicallee 7y ago

>- Many financial institutions are required to hold a certain percent of portfolio in safe assets. German bunds are among the safest in the world. Can you explain how this can possibly beat cash? If I say to you "I'll let you pay me ten cents to hold onto your $100 bill for a while, and give you a paper showing the obligation to repay your $100" (the meaning of a negative yield bond), how can the offer to let you pay ten cents to let me hold your $100 possibly be less risky than just holding the $100? Why would a bond with a negative yield ever be a safer asset than just holding the cash?

deleted 7y ago
[deleted]
blawson 7y ago
Maybe at certain sums much larger than individual depositors concern themselves with, you can't just "hold the cash". Like banks might say there is no way we want your $10 billion in cash to look after. Either invest it yourself or pay us to invest it for you.
- josefx 7y ago
  You really don't want $10 billion in a bank. Laws mostly guarantee a few hundred thousand per account holder if the bank itself has financial issues. You would have to spread that amount over quite a few banks if you wanted it secured.
auntienomen 7y ago
The world is different when you're dealing with really large amounts of cash. You can't just store it yourself; your mattress isn't big enough. And if you ask a bank to store it for you, the bank will charge you for the service. (Banks that work in this line of business are known as 'custodian banks'.) Consequently, the effective interest rate on cash for large amounts of cash can be negative.
whatok 7y ago
You can argue safety (bonds you have sovereign default risk vs cash will have bank credit risk) but your math is not incorporating how a transaction in this case would actually take place. It's not as simple as just holding onto $100. You have a deposit rate of -0.40% at the ECB. So instead of -0.40%, you settle for -0.14% which is what these newly issued Bunds are yielding.

shpongled 7y ago

Also, you can sell or buy bonds at any time - you're not locked in for 30 years. I think this is a crucial point many don't understand

simonebrunozzi 7y ago

Great comment, however: > the central bank buys bonds with money it creates from thin air QE generates inflation in the long run, which would by definition make these bonds less valuable over time.

solatic 7y ago

> - Many financial institutions are required to hold a certain percent of portfolio in safe assets. In practice this is turning into unnatural demand guaranteed by the law, which goes against free markets and will eventually implode upon itself. If you force the market to buy a certain product regardless of quality, then the underlying quality of that product will erode (as there is no longer an incentive to provide quality and quality implies cost), and the market will evaporate as stakeholders disappear and move to other markets which do assure real quality. That there was natural demand for such products in the past, and indeed that natural demand may coincide with unnatural demand in the present, is not a guarantor for demand levels staying natural in the future. In context, this creates underlying pressure for investors to divest from Euro holdings. It's likely that investors are currently sticking with the Euro because they have few other avenues for escape, but this is not likely to hold - whether due to Brexit/Euroskepticism or some other external crisis which changes the playing field.

landivar2 7y ago
When you have a central bank that can control rates, no alternative money, and the bank can set rates negative, the equilibrium is for the government to own almost all assets. I'm not kidding. You will end up with communism, only via government regulation of rates, unless something breaks this up.
- kthejoker2 7y ago
  If our capital markets are so unproductive that having the government own the assets is considered a net economic gain, we'll need all the communism we can get. The central bank does not "control" rates, they respond to the market signaling where rates should be.

dvfjsdhgfv 7y ago

> - Anticipated rate of inflation matters a lot because investors seeking return through yield focus on real interest rates (nominal rate - inflation). Inflation can be negative as well (deflation). If inflation is lower (more negative) than the bond's nominal return, that's a real positive yield. And that positive yield is locked in for the term of the bond, which in the case of the story is 30 years. But for this and the other reasons you mention, wouldn't cash be in any case better than the bonds?