The recent rising demand for negative yield bonds in the global market has ignited discussions around this seemingly counterintuitive financial instrument. Negative yield bonds, essentially debt instruments, offer to pay the investor a maturity amount that is less than the purchase price of the bond. They are generally issued by central banks or governments, and uniquely, it is the investor who pays interest to the borrower.
Understanding Negative Yield Bonds
Negative yield bonds effectively turn the regular bond market logic on its head. A bond is an instrument used to borrow money, typically floated by a country’s government or a company aiming to raise funds. The yield of the bond is the effective rate of return it earns. However, the rate of return is not fixed and varies with the price of the bond.
Investors usually purchase bonds at their face value, the principal amount invested, and earn a ‘yield’ in return. Each bond carries a maturity date when the investor is repaid the principal amount. Negative yield bonds, however, promise to pay back less than the purchase price, meaning investors effectively lose money over the life of the bond.
Why invest in Negative Yield Bonds?
Investment in negative yield bonds can seem puzzling, but there are several strategic reasons behind this choice. Some investors use them to diversify their portfolios or as collateral for financing, regardless of their yield. Foreign investors might anticipate a rise in the currency’s exchange rate, offsetting the negative bond yield. Domestically, investors may expect a period of deflation, where prices in the economy drop.
Negative yield bonds can also act as safe haven assets during periods of economic uncertainty. Investors may accept a negative return if it potentially means avoiding a larger loss that could occur in volatile equity markets.
The Current Scenario
With the world grappling with the economic impact of the Covid-19 pandemic and low-interest rates associated with bonds and other financial instruments in developed markets, investors are seeking higher-yielding debt instruments. Recently, China sold its negative yield bonds for the first time, experiencing high demand from European investors.
Soaring Demand: Low-risk Chinese Bonds
The high demand for Chinese bonds stems from a comparatively higher yield offering than that of ‘safe’ European bonds and the positive growth forecast of China’s Gross Domestic Product (GDP). While many large economies face contraction, China is recording growth, with its GDP expanding by 4.9% in Q3 2020. Additionally, China has demonstrated effective pandemic control, enhancing its appeal as a stable investment region.
Factors Driving High Demand
Two significant factors are driving the increased uptake of negative yield bonds: the availability of money and risk avoidance. To mitigate the economic impact of the pandemic, global central banks have injected huge amounts of liquidity into the financial system, with estimates exceeding 10 trillion dollars. Consequently, investors are using this cash to temporarily park money in negative yield bonds, intending to hedge their risk portfolios in equities to minimize potential losses if further lockdowns occur in response to the Covid-19 pandemic.
