Friday, June 1, 2012

Negative Medium Term Bond Yields - Another Sign of Desperation

Back in January, I posted an article regarding the desperation in the world's bond markets as investors flee to the so-called "safe haven" investments.  In this article, I noted that Germany's Bundesbank auctioned off 6 month Treasury discount paper with a negative yield.  In this particular case, investors were willing to lend the German government money and accept less in return when the Treasury paper matured six months into the future.  This was the first time that the German government had been able to auction off their paper offering investors a negative yield.  The situation in Europe was so desperate that investors couldn't get away quickly enough from higher risk PIIGS paper.

Here is a screen capture from the Bundesbank website showing the prices and yields of German Federal securities with a maturity range from 2 weeks to 32 years:

Please note that these are the prices and yields that result from trading on the open market, not those set by the Bundesbank.  You'll notice something interesting.  For the first time, the yield on the 2 year Bund (April 1, 2014) turned negative, yielding -0.02 percent.  Yes, you too have the opportunity to send the German government your hard-earned money and get less in return on April 1, 2014!  You'll also notice that the yields on the other Bunds maturing in 2014 range from -0.02 to 0.00 percent.  The yields on the Bunds for 2015 don't look that great either, ranging from 0.02 to 0.07 percent.  To put this into perspective, on a €10000 3 year Bund at 0.07 percent, an investor will collect a massive €21 euros in interest after the three years are up.  Don't spend it all in one beer hall!

There are two reasons why this is happening:

1.) The flight to safety as I noted above.  There's a lot of marginally serviceable sovereign debt out there in the eyes of investors.  This flight to safety goes beyond Germany; investors are pushing down the yields on the bonds of such notable debtor nations as the United States and the United Kingdom.

2.) Germany simply hasn't accumulated enough sovereign debt to supply all of the bondholders wishing to purchase their safe-haven paper.  As bond demand outstrips supply, prices rise and yields fall in lockstep with the rising prices.

To put these rates into a longer term perspective, here is a chart from Bloomberg showing the yield on the 2 year Bund over the past five years:

For fun, let's look at the yield on a 10 year bond.  Here's the chart for the 10 year Bund showing how yields have dropped to basement levels, hitting 1.2 percent:

Now, let's compare the charts for the Bunds to the chart for Spain's two year bonds noting how yields are moving sharply in the opposite direction to Germany's:

In closing, let's look at the chart for Italy's two year bonds keeping in mind that Italy holds the world's third largest nominal debt that seems to have avoided the scrutiny of the mainstream media thus far:

Understanding that bond yields rise and fall in the opposite direction to bond prices which rise as demand rises and fall as demand falls, it's not hard to tell which nations are deemed debt pariahs by the world's bond traders.  That said, it is still completely beyond me why anyone, anywhere would pay any nation to hold onto their funds by accepting a negative yield on a bond because, after all, paper is just that, paper.  I guess it tells us just how desperate the world's current sovereign debt situation has become.

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