Investors to bond issuers: “We’ll pay you to borrow money from us.”
As interest rates around the globe have edged lower in recent weeks, the amount of negative-yielding debt has been growing.
Year to date as of June 26, 2019, 186 bonds totaling $1.4 trillion have been issued at negative yields, already surpassing 2018’s total of $309 billion.
The market value of the bonds in the Bloomberg Barclays Global Aggregate Index is $54.6 trillion (as of June 26, 2019). Of that amount, $12.9 trillion (23.6%) currently has a negative yield; its weighted average yield is -0.31% with a maturity of 5.1 years.
This current amount surpasses its previous high of $12.2 trillion during the summer of 2016 when yields in many countries touched their all-time low. At that time, the percent of the index with a negative yield reached 25.7%.
On its face, the global bond market, with its inverted yield curves and $trillions in negative-yielding debt, would seem to be in defiance of the laws of not only finance, but of human nature itself.
Lenders take on the risk of lending with the expectation of earning a profit. Outside a deliberate act of charity, it goes against our nature to lend money knowing it will result in a loss. So what are investors to make of this? What circumstances or conditions would rationalize such a transaction?
A simple thought experiment may offer some insight. Suppose Mr. Smith lends Mr. Jones $1 million for three years. At the end of three years, Mr. Smith (the lender) will pay Mr. Jones (the borrower) $15,000 when Mr. Jones repays the $1 million. What could possibly motivate Mr. Smith to make such a loan?
Barring charitable intentions, the only reason Mr. Smith would lend at such terms is if he expects the purchasing power of his $1 million to have increased by more than $15,000 three years from now.
Such a phenomenon is the opposite of inflation, otherwise known as deflation.
While there is currently no deflation occurring in any of the world’s major economies, these negative yields offer some indication of the bond market’s projection for future deflation.
If the bond market is right and the world is indeed headed for a deflationary period, it would seem that the Fed can’t ease policy fast enough.
Unless otherwise noted, data is sourced from Bloomberg.
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