Can someone please explain why people were buying 10 year bonds „yielding“ negative 0,50% just few years ago? pic.twitter.com/yJJjILUylb
— Michael A. Arouet (@MichaelAArouet) May 30, 2024
- Nominal vs. Real Rates:
- When you see a bond yield, such as the yield on a 10-year U.S. Treasury bond, that’s typically a “nominal” rate. It represents the interest rate without adjusting for inflation.
- However, what really matters to investors is the “real” yield—the yield adjusted for inflation. Real rates take into account the actual purchasing power of the money earned from owning the bond.
- Why Nominal Rates Declined:
- Nominal interest rates have been declining for quite some time. Factors like the global financial crisis and the COVID-19 pandemic led investors to seek safe-haven assets, including U.S. Treasuries.
- As demand for Treasuries increased, nominal yields dropped to record lows.
- Inflation Expectations and Real Yields:
- In early 2021, economies began reopening, and economic growth resumed. This led to rising inflation expectations.
- Despite this, investors continued to buy Treasuries, resulting in a disconnect between nominal yields and inflation.
- The 10-year U.S. Treasury yield was around 1.3%, while inflation expectations were around 2.3%. The real yield (adjusted for inflation) was approximately -1.0%—meaning investors were essentially expected to earn a negative 1.0% real yield annually1.
- Who Bought Negative Yielding Bonds?
- Foreign investors played a significant role. As the U.S. economy reopened, imports from other countries increased. Many of these exporting companies and countries bought U.S. debt to build up their foreign exchange reserves.
- Additionally, while nominal yields were low in the U.S., they were even lower in other parts of the developed world. Foreign investors found U.S. Treasuries relatively attractive due to their (relatively) higher yield1.
- Economic Implications:
- Holding a negative-yielding bond to maturity guarantees an economic loss. The only potential gain is selling the bond to someone else at an even lower yield (finding a “greater fool”) before maturity.
- The rise of negative bond yields is complex, but it highlights the unusual economic environment and investor behavior2.
In summary, negative bond yields occur when investors are willing to accept a guaranteed loss in real terms due to various factors, including global economic conditions and relative yield differentials across countries3. It’s a fascinating phenomenon that challenges traditional expectations!
h/t AI
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