One of the more fascinating financial developments of the post Great Recession period was the advent of negative yielding bonds. This is a condition present when the premium paid for a bond is so great relative to its par value, it exceeds any income the investor receives while holding the bond to maturity. Put differently, let’s say I loan a friend $103 in return for $100 in two years time and annual payments of $1. The premium I paid is $3, and the interest earned is $2, leaving me with a negative yield. Now, up until the last decade, negative yielding bonds weren’t really a thing – I mean why would there be any demand for an investment guaranteed to lose money?
There are several theories as to how we ended up with more than $18 trillion in negative yielding bonds in late 2020. Of course, there was the flight to safety during the pandemic – but even pre-pandemic we hit $17 trillion in negative yielding bonds globally, with the suspected culprits in 2019 being low rates of economic growth, easy monetary policies and demographics (an aging world paying up for safety). Then, as economic growth accelerated, the value of negative yielding bonds fell to $7.5 trillion before the COVID-19 induced spike to $18 trillion.
Today, we are down to $13 trillion in negative yielding bonds. What should we make of this march towards zero (which is still, admittedly, a long ways off)? A few thoughts: rising bond yields reflect rapid global economic growth and fears of inflation; much of the move from negative to positive yields has taken place in Europe (10-year yields in France and Ireland have turned positive). This should point to better economic times to come on the continent, and it is a reminder one can lose money in bonds (though they remain the only true hedge for equity exposure).
In our discretionary portfolios we have a neutral position between U.S. and non-U.S. equities and are conservatively positioned within fixed income. We think yields are biased higher, a dynamic that should weigh on traditional fixed income and prove additive to market volatility.
Tagged: Tim Holland, weekly wire, market perspectives, U.S. economic growth