For students new to the fields of finance and economics, bonds might be a foreign concept. Essentially, it is a form of debt held by governments. Bonds are issued and sold by, in this context, Governments to buyers. And like all debts, bonds must be repaid with interest after a certain amount of time. If you’re already familiar with bonds, then you can skip the next section.
A Basic Rundown for Students
If you’re taking Investment and Finance, then this will be a good opportunity to learn about bonds outside of the lecture slides. As mentioned above, bonds are (in this case) debt held by the government. An important aspect of bonds is the concept of maturity. When a bond matures, the issuer (the government) must pay back the principal (how much it cost) of the bond. The time at which the principal must be paid back is known as the bond’s maturity date. And the duration from the time the bond is issued to its maturity date is known as the bond’s time-to-maturity. This can last anywhere from 1 year to 30 years. During this entire period, interest payments must be made to the buyer. This is determined by the bond’s coupon rate, which is in turn determined by the interest rates in the economy. The combination of the bond’s principal and all the coupon payments represents the total profit an investor makes from investing in bonds, also known as the ‘yield’.
In recent months, Germany’s bond yields have been on a decline. And as of 21 August 2019, for the first time, the government auctioned a 30-Year Bond at 0% interest with a yield of -0.11%. The curve below shows the history of German bonds, the different times-to-maturity, and their yield percentages.
View the full yield curve app here
What does it mean, then, to have negative bond yield? By buying negative-yielding bonds, investors are agreeing to make a loss, given that they hold the bond to maturity. But why? The prevailing narrative is that fears of a recession are causing investors to invest in safe-haven assets (in this case, government bonds). When the demand for bonds goes up, so does the price.
Since bond price and bond yield have an inverse relationship, bond yields get pushed down, and when taken far enough, become negative.
This isn’t a far-fetched intuition, as the German economy has gone awfully close to being in a definitive recession in the first quarter of 2019, after GDP growth had been shrinking since 2018. In fact, the latest reports indicate that demand for German manufacturing and services has continued to plummet over recent months. Consequently, this adds further fuel to the fire that is the negative outlook on the German economy, heavily implying that a recession is around the corner.
Combined with the uncertainty of Brexit, it may be that investors just aren’t confident enough in the German economy’s performance; they would rather put their money into safe bonds, even if it means a guaranteed loss of money.
Interestingly, there is talk of certain groups of investors choosing to buy negative-yield bonds as part of a strategy. And that they may actually bring positive returns despite the negative rates. However, that is a topic for another article.
Source: plotly visualization, Bundesbank, TR