What do negative yield bonds mean for investment? I understand the basic idea that we pay more than face value to buy a bond. However, I am missing “so what?” —I read an article on Kiplinger that during deflation, you are better off even with -ve yield. However, I’d argue that during deflation, wouldn’t we want to keep the cash in our account? I’d appreciate if someone could help me understand these negative bond yields.
Negative yields on bonds imply negative returns if held to maturity. Though further decreases in yields will increase the value of bonds hence generate a positive return (given there’s a buyer). Once such buyer is a central bank. Open market operations, like conducted by the European Central Bank, push down interest rates, increasing the value of bonds for bondholders (even though yields are negative).
Who else would buy negative yield bonds? Institutional investors, such as pension funds and insurance companies are constrained by mandates to buy bonds according to their strategic asset allocation (used to match their liabilities). Holding cash is actually more expensive for institutional investors than buying negative yield government debt (which is almost as liquid).
On the topic of deflation: even though a bond may have a negatieve yield in nominal terms, a period of deflation (negative inflation) will increase the investor’s return in real terms (purchasing power). Remember, just as inflation hurts lenders (bond holders) because the value of money they lent has decreased in real terms, deflation works the opposite way.
If interest rates decrease, the value of the bond increases (inverse relationship). If you sell the bond, you lock in a positive return. If you hold it until maturity, you will earn a negative return since you receive par value versus the premium you paid at time zero.
Banks charge negative interest rates on cash deposits for institutional investors (simply take a look at the yield curve for short maturities). This is different from private investors that have cash in their savings account earning a marginal positive interest rate (if not, it would result in a bank run). An alternative would be to actually store cash physically in a vault and pay for the protection of the stored cash (which can be quite expensive as well).
This is true for a private investor that stores the cash in a box under their mattress. Though for institutional investors this isn’t feasible (you can store it in a vault like I said but that incurs storage & insurance costs). Bonds are the next best alternative as deflation will increase the value of bonds (remember the Fisher effect: nominal interest rate = real interest rate + expected inflation).