QE and deflation drive bond yields into negative territory

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The proliferation of bonds offering negative yields raises questions about the drivers and reasons why investors would be buying into this trend. 

In the good old days, the point of investing would be the allocation of money into an asset with the anticipation that it would increase in value.In today’s brave new world, however, investors seem to be prepared to allocate money into sovereign and even some corporate bonds offering negative yields. What are the drivers behind this phenomenon and why are investors buying into it?

Swiss food producer Nestlé recently issued 2016 bonds with a yield of -0.002%, a not so lucrative snack for European investors. The multinational thus follows the trend of sovereign bond yields in a number of European countries, with Austrian, Swedish, Finnish and Dutch five-year bonds entering negative territory, not to mention Switzerland, where even 13 year treasuries are now negative. And among the corporates it is not just Nestlé that has triggered investors’ appetite for bonds. Yields for Shell, Novartis, BASF or Nederlandsche Gasunie are currently close to 0%.

A key driver behind this move is of course monetary policy. The ECB’s pledge to buy more than €1trn worth of public and private debt has driven bond prices up, generating
a drop in yield prices. Investors who buy these bonds therefore speculate that further QE measures will have a similar effect on prices. “Massive quantitative easing measures by the ECB and other central banks, notably in Japan, will keep the pot boiling for much longer. The ECB has a €1trn QE programme while Japan’s Abenomics is virtually infinite,” comments Lukas Daalder, CIO Investment Solutions at Robeco.

The historically low interest rates set by banks have also influenced bond yields, argues Arnold Gast, manager fixed income credit at Delta Lloyd Asset Management. “As long as the decline of interest rates continues, existing obligations, particularly those with a higher coupon are set to benefit, particularly spreads on corporate bonds are still offering opportunities to additional returns. But the key question is when it is time to exit in order to
reduce risks.”

Another driver is a widespread anticipation that the current deflationary trend will persist. “It makes some sense because if we are really in deflationary environment, and investors expect that it will continue, then bonds with negative yields can still generate positive returns in real terms. But this is not our preference and the negative yield approach makes little sense for us as long term investors,” comments Jérôme Teiletche, head of Cross-Asset Solutions at Unigestion.

Another factor that drives the yield gamble is currency speculation, as Daalder highlights: “A positive currency movement can realise a profit, such as for investors who bought negative-yielding Swiss bonds and then benefited when the Swiss franc was revalued.”

While the theoretical case for negative yield has been made, most investors remain cautious. Michael Strobaek, CIO at Credit Suisse warns: “We have decided to go underweight in German Bunds. Experience with QE in the US
shows that yields tend to decline ahead of the decision and actually increase during the purchasing program. We could see a similar development for Bund yields.”

Similarly, he advises selling Swiss bonds and not to buy and long CHF denominated bonds. “If investors must remain in CHF bonds, they should reduce duration or move to cash-like,” he argues. Robeco’s Daalder also stresses that he while he sees the theoretical arguments in favour of negative yields, he would not actively seek to buy them.

Similarly, Teiletche is not convinced: “While we are looking for strategies to find income sources going into corporate, we foresee that there will be plenty of liquidity issues if we go too far down in the rating spectrum”“Although we have been longstanding advocates of buying bonds, early February, we bought some puts on US Treasuries as we thought the market overreacted to lowerinflation”

Overall, while arguments can be made in favour of buying bonds with negative yields, many investors, particularly those with a long-term investment horizon, remain sceptical of the risks.


• As of 9March 2016, the ECB will conduct monthly €60bn purchases of public and private sector msecurities, lasting at least until September 2016.

• The ECB has already purchased a monthly €10bn worth of covered bonds and asset backed securities since last year.

• The ECB pledged not to buy more than 25% of each issue, and not more than 33% of each issuer’s debt.

• Purchases will be based on the ECB’s capital keys, which means that around a quarter of total bond purchases will be German.

• The ECB’s standards on risk sharing mean that each of the central banks will buy the bonds of its own government, the ECB itself will hold only 8% of the additional asset purchases.

• All purchases will be conducted in the secondary market.

• Bond maturities will range between two and 30 years. • ECB purchases can include bonds already trading at negative yields.

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