Wednesday, January 11, 2012

Negative Sovereign Bond Yields - A Sign of Fiscal Stress

A financial news story from earlier this week received very little media attention, particularly considering its importance in the scheme of the unwinding of both the Euro and the European Community and the world’s overall sovereign debt crisis.

On January 9th, the Bundesbank, Germany's central bank, auctioned 6 month German Treasury discount paper maturing on July 11th, 2012.  A total of €3900 million was auctioned with bids received for €7080 million.  Here is a summary press release from the Bundesbank showing the results of the auction:

Notice that the lowest accepted price was 100 percent and the weighted average price was 100.00616 percent with average yield over the entire auction of negative 0.0122 percent.  Yes, you read that correctly, the yield on a 6 month German Treasury was negative!  In case you are confused, remember that Treasuries (including those of the United States, Canada, the United Kingdom et al) are purchased at a discount and redeemed at full value.  For example, a one year Treasury yielding 3 percent will be purchased at a 3 percent discount from its maturity value and then redeemed for 100 percent of its value upon maturity.  In this week's case, purchasers of German Treasuries actually paid an average of €100.00616 for every €100 worth of Treasuries that they will only be able to redeem for €100 on July 11th, 2012.

This is the first time in history that a Bundesbank auction of short-term German government bonds have resulted in a negative yield.  This means that buyers of the German Treasuries are actually paying the Bundesbank for the privilege of owning their paper.  

This is not the first time that German bonds have traded with a negative bond yields, however, in the other cases, the yields became negative on the open bond market as shown here:

Notice that all of the short-term bonds maturing in 2012 at the top of the list have negative market yields.

This is not the first time that European government issuers have auctioned bonds with negative yields.  Switzerland, Denmark and the Netherlands have all recently sold bonds at negative yields.  This shows us just how desperate the world's sovereign debt situation has become.  Major bond investors are either avoiding the bonds of debt-encumbered Eurozone nations or demanding punishingly high yields as shown here in the case of Italy's 6 month bonds:

Why would anyone purchase a bond with a negative yield?  First, risk avoidance has become the name of the game.  Investors are looking to hide their cash wherever they perceive safety, unfortunately, safety is just an illusion.  Second, Europe's private sector banks can purchase government bonds and use them as collateral against funds that they wish to borrow from the European Central Bank.  These funds which are borrowed from the ECB, most recently at 1 percent, are then loaned to consumers.  Unfortunately, the credit market in the Eurozone is very tight, with credit standards rising as shown in this article.  This is part of the problem facing the Eurozone; banks no longer trust each other, consumers and corporations and are depositing their overnight funds with the ECB rather than with other banks.

Seeing negative yields on rising levels of sovereign debt is a relatively new phenomenon.  Remember, that while Germany is the most prudent of the Eurozone nations, it still sitting on €1.116 trillion of debt.  Bond investors are now choosing among the best of a bad lot but that doesn't necessarily guarantee that their decisions will pay out over the long term.  The fact that any investor would pay any government to hold on to their cash for them is a very telling sign that the system is broken.


  1. I'm trying to figure this out. Why are the bonds more valuable than the money (with higher face value) used to purchase them? Do the bonds have uses that the cash wouldn't? (If bonds are useful as collateral, why isn't cash as useful?) Are these bonds being bought for entities or people (not banks) who don't want to keep deposits in banks, but rather own a bond that can't go into a bankruptcy limbo? I need an explanation at the level of college-educated layman, if possible. Thanks.

  2. MP

    European banks are using these bonds as collateral with the ECB to borrow even more than the face value of the bonds since they are operating under a fractional reserve system just as we are in Canada and the United States.

    These investors also have to have some place to put billions of dollars and since the vast majority of them are not individuals but institutions, they have no mattress to stuff their cash into. They are concerned that they might lose their principal if they invest in less credit-worthy bonds and find themselves facing a haircut as in the case of Greece and their 50 percent loss in value.

    You are also correct in assuming that the banks are not deemed safe. Overnight deposits with the ECB have recently reached new levels meaning that Europe's banks do not trust each other.

    Welcome to OUR future!

    Thanks for the comment - hope I cleared up some of the questions you had. The whole situation is most disconcerting, isn't it?

    1. There's still one question left. Why is a good government bond better collateral than a cash deposit?

      As for it being disconcerting, it's hard for me to judge. Speaking from experience (minus solid understanding), I remember the LIBOR (interbank) rate being high during the mortgage crisis in 2008 as a sign that credit markets were frozen and firms had to contain costs in dire ways. If it's the same in Europe, yes, that's a bad sign. I don't know if business there are as dependent on outside finance as American firms were.

      One reason I'm not totally worried is that I'd like to see the whole world depend less on debt and leverage, which means that I too will be receiving less return on my investments. But, as I've written, I'm not completely averse to the mattress approach.

  3. That question, I cannot answer. Tomorrow's posting will take another look at foreign reverse repurchase agreements with the Fed, showing how they've grown, just as they did in 2008 as well as the record level of overnight deposits with the ECB. Both show that the credit freeze up is far from over and with the world's economy being so interconnected, what impacts one major trading partner, impacts all.

  4. For MP

    There is something interesting that most people do not know about:that during the Great Depression (1930) the bonds had negative interest rates around 2%. What that really mean could be described in one word: Deflation! Negative rates are a clear indicator of deflation.

    1. I wouldn't want to be a central banker right now. You have to tread a very thin line. They're injecting a lot of new money into the system to try to prevent deflation and frozen credit markets, but they risk inflation and asset bubbles by doing that. I hope the world can stabilize and they can back off the spigot soon. (Caveat: just a layman's view of the situation. But this layman knew Greenspan was printing too much money before he did.)

  5. IMO Wealth is nothing more than "PERCEPTION thru DECEPTION" and everyone wants different than power. The media is very good at this perception..Makes for good conversation. Stock market makes it happen.