Negative Yields

Many years ago, Walter Bagehot noted that “John Bull can stand many things, but he cannot stand two per cent.” Well, since the Great Recession, he has had to stand yields well below that. Actually, in many countries, investors have to stand interest rates below zero. How logical is that?

And the virus of negative yields is quickly spreading. In September 2019, the amount of global debt with negative yields amounted to about $16 trillion, or more than 25 percent of the market. This number has nearly tripled since October 2018. Even the 10-year German bond went negative (see the chart below), while Nordea Bank, a leading Danish bank, said it will begin offering 20-year fixed-rate mortgages with zero interest, as well as 30-year mortgages at minus 0.5 percent. Isn’t this economic madness?

Chart 1: 10-year German government bond yields from January 2010 to August 2019.

German government bond yields and gold chart

Normally, instead of spending it themselves, lenders offer the borrowers money, in return receiving the promise of being paid back, and interest. Negative bond yields seem to turn the credit relations upside down. But they do not mean negative coupon payments. Negative yields imply losses for investors who purchase these bonds and hold them until maturity, not for all bond investors. 

Let’s assume that the Dutch government issues one-year bond with a nominal value of €1000 and a coupon of 1 percent per annum paid at the bond’s maturity date. If the bond is quoted at nominal price, then the yield to maturity is 1 percent. What happens when the bond price rises to €1020? In this situation, the yield to maturity drops to almost -1.0 percent. This is because the investor who bought the bond at €1020, will receive only €1010 at maturity, losing €10. However, if the price of bond rises further from €1020 to €1040, the investor will enjoy the positive return of 1.96 percent (20/1020), although the yield to maturity will drop to -2.88 percent (30/1040).

As you can see, it is still possible to gain in the environment of negative yields, but this can continue only as long as the bond prices are rising. One has to simply find a greater fool to whom he or she can resell the bond. Or maybe not a fool – after all, investors, quite rationally, bet that the central banks will always step in and purchase as many bonds as needed.

Negative Yields and Gold
What do negative bond yields imply for the gold market? Well, the spread of negative bond yields should be fundamentally positive for gold prices. The subzero yields reflect the flight to safety. Investors scramble for safe haven to park securely their hard-earned money. But gold is the ultimate safe-haven asset and no one’s liability to boot.

Moreover, with yields deeper and deeper below zero, buying government bonds is riskier and riskier, while the opportunity costs of holding golds are lower and lower. When real interest rates are low and going down, gold will look increasingly more attractive.

The yellow metal does not bear any yield, so in normal times, it is often passed over for more lucrative assets. But in the world of negative yields, not bearing any interests is actually a blessing.