Buy Bonds with Negative Yields?

03/11/2015 12:01 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The negative yield of EuroZone bonds may seem crazy, but MoneyShow's Jim Jubak explains why it can make sense.

Now, I don't know what you sit around and talk about at your dinner table.

Maybe you're a UVA basketball fan and you're trying to figure out whether the team can somehow get from being number two to winning a national championship this year or you like baseball and you're talking about who has enough pitching this year.

Well, what we talk about at the dinner table is why buying bonds with a negative yield actually makes sense.

You've got a lot of European sovereign debt bonds that are actually showing negative yields. You can basically buy a German bond and, for the privilege of lending the German government money, they charge you so you're paying to put your money out there and the question, of course, well, why this makes any sense.

From one perspective, let's say you're a bank, it makes a lot of sense to buy these. The European Central Bank, in an effort to get the banks to lend, has basically said, “Well, you know, we used to pay you to deposit your excess funds with us in the Central Bank but, now, we're going to charge banks,” so if you're looking at banks being charged two-tenths of a percentage point to any basis points to store money with the ECB or looking for some other place to put money safe and they can do a short-term trade with a negative yield of only 10 basis points, it makes sense.

On the other hand, what you really got is a lot of this is being driven by traders speculating on what the effect of the European Central Bank's big asset purchase plan, it's plan to buy about $1 trillion euros worth of mostly government bonds, and what these traders are looking at is they're going, “Okay, so the ECB, the European Central Bank, is going to buy bonds weighted by, basically weighted by the size of the economy,” so, for example, that means they're going to go out and want to buy a lot of German government bonds.

There aren't a whole lot of government bonds for sale in Germany. Germany doesn't run a big deficit. They haven't been issuing lots and lots of paper, so it's pretty thin so, to do this, the ECB is going to have to go out in the market and convince people who own these bonds to sell them and what the bet is—that this is going to cause prices of those bonds to go up and this would actually be a profit—so that buying a bond now on the expectation that the $1 trillion euro purchase plan by the European Central Bank will drive up bond prices is what makes buying a bond with a negative yield make sense.

These are not traders and these are not investors that are planning on holding these things. These are traders that are looking to see whether the ECB's asset purchase plan gives them some kind of a balance in the relatively short-term.

Looking at short-term interest rates also to see whether they stay negative, whether they go positive, will also tell you a lot about whether the European Central Bank's plan that was announced the week of, well, it was announced on March 5, the details were announced after the meeting in Cyprus. Watching negative interest rates to see how they move will tell you a lot about whether that plan is going to be effective in any fashion, so watch negative interest rates and that's why they make sense.

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