Why investors buy bonds with negative returns | Charts that Count

Why investors buy bonds with negative returns | Charts that Count

Why would anyone want to
buy an asset that they knew would lose money? Like any fixed
interest rate asset, when you buy a bond if you
pay a higher price for it you get less back
in terms of yield. Now yield just refers
to the interest rate that a lender gets in
return for lending money. So just remember the higher
the price, the lower the yield. The two have an
inverse relationship. Now this chart is
looking at the yield on the German 10-year government
bond, which they call the bund. Now as you could can see
the yield on the bund has been declining,
and declining so much lately
that it’s actually gone into negative territory. And it’s trading right
now between negative 0.2 and negative 0.3 per cent. This happened for the
first time back in 2016, but we’re actually
at a lower rate now than we were back then. What this means
essentially is that people are paying such a high
price for these German bunds that they know that
they’re paying for more than they’re going to get back. Why would anyone do this? They’re paying for the
privilege of losing money. Why wouldn’t you
just hold on to it? Well let’s start by talking
about European banks. The ECB charges European
banks 0.4 per cent to hold their money in deposits. Now negative 0.4 per cent
is actually much worse than negative 0.2 or
negative 0.3 per cent from the bank’s perspective. So they’d much rather put it in
these bunds than with the ECB. And this is actually by design. The ECB wants banks to
invest their capital out into the economy rather than
just sitting on the cash. Now here’s a second
reason that some investors might want to buy these bunds. It’s because they’re
safe and they’re liquid. So the German government is
considered a reliable borrower, making their bonds safe. They also can be traded
on the secondary market relatively quickly,
which makes them liquid. If the eurozone
economy goes down, then assets like equity
or corporate debt, they’re going to
perform much worse than these German bunds will. So even though there’s
negative yield, it’s a price investors are
willing to pay for that safety and liquidity. Now here’s a third
reason why someone might want to buy these
negative yielding bunds. The ECB has recently
signalled that it may want to buy more sovereign debt. That would push up the
price of these German bunds. So if you’re an investor and
you think the price of something is going to go up
in the future, you may buy it now so that
you can sell it later, making yourself a little profit. So these are just
some of the reasons why people may want
to buy German bunds, even though they have
a negative yield. But it’s not all of the reasons. In general it’s
important to know that even though
on its surface it may seem silly to buy a
negative yielding asset, there are some reasons why
it actually makes sense, even though right now
it essentially looks like a guaranteed loss.


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