Negative Yields

One recent area of concern has been the extremely low level of interest rates. The 10-year US Treasury bond touched its lowest yield ever this morning, breaking below 1.36%. The 10-year government bond in the UK (the Gilt) yields .77%, while 10-year government bonds in Germany (Bunds) and Japan (JGBs) have negative yields. Every single Swiss government bond has a negative yield, even the 30-year bond! A negative yield may sound like an oxymoron, but it means that you’ll get paid back 100 cents for every 105 cents that you invest (as an example). So if a negative return is assured, why would anyone buy a bond with a negative yield? There are some buyers that do not care about performance, such as central banks and index funds; however, there are others that know it is foolish to buy at 105 but think they can sell at 107 (even though it will only pay out at 100 at maturity). This type of behavior is explained by the eloquently named “Greater Fool Theory,” which implies that a fundamentally-flawed high price can be perpetuated by selling assets to others that will also buy at ridiculous prices. This price action can continue for extended periods of time (think internet stocks or residential real estate) and the bond market may continue to rally for some time, but we know that there will ultimately be losses (in fact, it’s already assured if you buy at a negative yield). Thus, although bonds have rallied a lot this year, we see extreme risks and believe a very high degree of caution, skill, and discipline is warranted.