Why would anyone buy a bond with a negative rate of return? It’s a question investors in some European country bonds are grappling with after yields dipped below zero in recent months. That means investors are paying countries for the privilege of lending them money.
Unfortunately for U.S. investors, the effects of negative yields aren’t restricted to the market for euro bonds. Negative yields overseas may be drawing more income-seeking global investors to the U.S. bond market, where yields are still above zero. That extra demand may be suppressing Treasury yields.
Once a rare occurrence, negative yields on bonds have now become quite common. More than $1.9 trillion of the euro region’s government securities had a negative yield at the end of February.1
What’s causing it? To help fight off deflation and spur economic growth, central banks in Europe have adopted negative interest rates in the hope banks will start lending more to consumers and businesses. Meanwhile, the European Central Bank cranked up a sovereign bond-buying program to further stimulate the economy. As a result, yields on bonds tumbled from already low levels.
Most of the demand for such bonds comes from institutions that are required to allocate a portion of their holdings to state-issued securities.
Kathy Jones, Senior Vice President and Chief Fixed Income Strategist at the Schwab Center for Financial Research, says most individual investors would be better off staying away.
She notes that Treasuries remain a better choice—yields are low, but they still have a way to go before they fall below zero—and cash might be the next best option.
1David Goodman and Lukanyo Mnyanda, “Euro-Area Negative-Yield Bond Universe Expands to $1.9 Trillion,” Bloomberg, 2/28/2015.