Negative Yield Corporate Bonds Really Growing Now

Many people are aware of how much more debt is held with negative yield government bonds these days, but corporate bonds can also trade at negative yield levels.

Bonds with negative yields can appear to be strange things indeed among those who do not really understand bonds that well. This can even surpass our imaginations when we contemplate why anyone would buy something to receive a negative yield.

The confusion here results in our thinking about bonds one way only, and focus on the yield side exclusively. We see bonds as instruments that pay us a certain amount of interest and if we hold it to maturity, we will receive this interest over time as our return on investment.

In other words, if we’re using bonds only to earn interest over time, anyone receiving a negative return would have a disincentive to invest in the bond, and this part is certainly true. Much of the bonds that change hands are not of this sort though, and the objective isn’t just yield, it’s total return, including both the potential capital appreciation and whatever yield the bond provides.

There are actually two distinct and popular ways to make money with bonds, with the first being holding them and using them as an income stream, and the second being our trading or investing in bonds with the primary purpose of speculating on price with them.

The yield is still going to matter, but bonds don’t actually pay negative interest. They all pay positive interest, called the coupon rate, and the yield is derived by adding this return to the difference between the purchase price of the bond and its face value at maturity, resulting in either a potential capital gain or loss. This is only potential at this point because this calculation also depends on the bond being held to the end and redeemed.

It’s actually the price rising that brings us into this negative yield territory, where the gain from the interest it pays isn’t enough to make up for the capital loss should it be held to maturity. If the price of a bond rises, the yield goes down, and the only limit on how much people will pay for a given income stream is only limited by the willingness of the market.

Lower yields are a sign of bullishness in the bond market, with negative yields an even bigger sign. This happens when the bulls take full control of the market and drive away the yield seekers, whereby their effect upon the demand of the instrument is more unopposed.

We need to remember though that there is a lot of money that is bet on bond prices going down, which is always an opposing force. A lot of the action in bond markets is not from those who are investing in bonds, it is from those trading them, which provides a lot of the liquidity in this market.

A Lot of The Liquidity in the Bond Market is Provided by Traders

Trading bonds here means buying them for the purposes of selling them later at a profit. Bonds don’t accumulate value over the long term like stocks do, so there is no long-term speculating here, and people either trade them or hold them.

If you buy a bond with a negative yield at the time of purchase, this does not mean that you will experience a negative yield, and if it did, we could rightly say that such a thing would not make sense. However, some bonds are actually purchased with no regard to return, as is the case with central banks. They buy bonds for reasons of monetary policy, and the expected return isn’t even on the list of the goals behind this.

A central bank may want to stimulate the economy by increasing money supply, so it buys bonds and the money that is used to purchase it gets added to the economy. These benefits then multiply as this money creates further new money by being loaned out.

When this happens, this also drives up the price of these bonds, which can stimulate more attention and cause a further rally. If the yields ae negative, the central bank doesn’t care as this is not relevant.

Governments love very low interest rate environments in fact, and are happy enough to see these negative yielding bonds out there because this is a time where they can pay a lot less in interest rates themselves with new issues.

There are also other institutions that may be bound in some way or another to buy bonds even though they may be priced highly enough to provide negative yields. This provides additional buying pressure even in these situations, and even if the holder would prefer not to receive a negative yield. The terms that required them to act here is what is driving these decisions in this case.

There are people that think that whenever the bond market heats up a lot, like it is now, this means bad times, and that people think so little of the future that they are willing to accept the much smaller yields of today. There are some who might, but the main thrust of these moves up are actually due to nothing more than price speculation.

When We Move to Bonds, We Can’t Just Look at Yields

We do see a flight to bonds at times, and people will have various objectives with the bonds that they fly to, and as long as returns are still reasonable in the context of inflation, buying these bonds with the purpose of holding them may at least seem desirable.

People who move money into bonds typically aren’t the people who hold things a very long time though, and the fact that they are doing this tells us that they aren’t in the habit of even holding their stocks.

They may also move out of bonds at some point, and when they do, the yield at the time of purchase won’t apply. When you move bonds at any time, right up until maturity, you get the price you sold it for, not the face value that is used to calculate yields the way we do and the way we commonly use the term,

These yields therefore don’t really matter in a lot of situations, a great many of them actually. Whether we wish to buy bonds at the yield they are offering will depend on our intentions, and there may be cases where it just doesn’t make sense to buy it, but when a lot of people end up here, this does not mean that the bond market experiences much negative pressure.

If you buy bonds with negative yields at the time of purchase, and their prices go up, the new yield will be even more negative but you can sell them for a capital gain plus whatever you earned in interest. This is what people try to do when they buy these negative yield bonds.

We’re seeing this more with corporate bonds as well, where people are speculating on them enough to drive them into negative yield territory. In an environment like this, companies can issue new bonds in a more friendly interest rate environment, saving them on interest costs.

We can take advantage of this as well should we wish, although the real money in bond trading is made by multiplying small gains by massive amounts of money, and stocks are still what you want to be in if capital gains is what you seek primarily. However, during those times where stocks aren’t performing so well, at times where you would normally think of moving to bonds over, doing so at a time where we may reasonably expect bond prices moving up is required to make sense of this move.

People often won’t consider this though, although they still may feel happy enough to take on smaller losses with these bonds than they would have if they had kept this money in stocks. This is a situation where we actually have a negative yield expectation, when we buy into bear markets with bonds and can lose money on them.

Unless we are genuinely looking to hold a bond to term, yields really don’t matter much, even if we’re looking at negative yields. This is not such a strange situation as long as you understand it.

Editor, MarketReview.com

John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.

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