As German Bund Yields Head to Zero, They Still Beat U.S. Treasuries
bloomberg.com
bloomberg.com
Even so, I think it’s a little disingenuous to compare EUR denominated T-notes with Bundes (which are natively EUR denominated). Of course if they just compared regular T-notes, with Bundes, they really wouldn’t be a story since T-notes are paying a great rate compared to any other government bonds.
Here's the missing question: Imagine you are a Eurozone pension fund or life insurer. You have to invest billions of euros very safely and eek out a return that is no less than inflation. How do you do that?
Inflation (HICP) was 1.73% in 2018. German Bunds, the safest euro denominated investment with sufficient volume, yield close to 0%. Now you look across the Atlantic and find that 10 year treasuries yield 2.63%.
The problem is that simply investing in treasuries wouldn't work because currency fluctuations would likely dominate any interest income. So you would need to hedge the currency.
The Bloomberg article is about why hedging the EUR/USD currency pair is currently too expensive for this idea to work.
It matters for European savers, including everyone who is paying into a defined contributions pension (e.g most workplace pensions). A significant chunk of those savings currently yields negative returns. The alternative is to take a lot more risk than you want to or are allowed to take.
Because the ECB had negative rates for a while, i.e. some parties had to pay to hold cash.
And lastly, because economic developments which don't affect cash, may affect bonds. i.e. if the interest rates drop, existing bonds will become more valuable. I don't expect this to happen, but the point is that you don't just buy bonds for their return today, but also in expectation for their relative return compared to the rest of the bond market in the future, i.e. their future value. That doesn't apply to cash in the same way.
Where do you hold the cash? Physically? As deposits in a bank? “Cash” is short hand. This article debates different forms of cash. (OTR sovereign bonds are usually considered cash.)
Instead of the usual layperson interpretation where cash is "a bunch of currency, either physically in my hand or in a bank account", the meaning here is "stuff with incredibly low risk" i.e. you can be very sure that you'll not lose money over time.
Sovereign debt, including bonds, is regarded as the safest type of debt and therefore falls into the 'risk-free' bucket in the finance world. Since cash is usually regarded as risk-free, the word "cash" has come to be a short-hand for "(almost entirely) risk-free assets".
For one, sovereign bonds are very obviously not risk free. Governments have a long history of going bankrupt or giving bond holders haircuts. They're treated as such because regulations passed by governments force them to be treated as such, which is clearly self-serving. The finance world is mixing up "we must pretend it's risk free" with "actually risk free".
Again, the fact that it's not considered that way says more about the finance industry than it does about ordinary terms like cash.
I'm not a fixed-income (read: bonds and other interest-rate derived financial instruments) person, but I think the erosion of 'value' via inflation is missing the point.
Sovereign debt is the least risky form of debt there is, period. Everything else that's denominated in the same currency has more risk, not least due to the fact that the pricing of every financial instrument takes the risk of the sovereign debt into account aka the risk-free-rate.
Yes, the absolute amount of risk of a sovereign debt is different depending on who controls a particular fiat currency - but in relative terms, any financial model will start with that baseline. Obviously, cash in that same currency bears some risk due to inflation, which is why people talk about 'real interest rates' that take that into account.
If you lend someone money, you take risk, and you get interest as compensation. That risk includes your predictions of inflation, and the interest rate you are prepared to accept should include that too. If you don't like it, don't lend the money.
Arguing about a 'transfer of value' implies that you have another way of representing value that is better than the currency itself. I can't think of one, but I'm open to suggestions.
A truly risk free currency would be a currency that couldn't be inflated by a government to escape from its debts, like a cryptocurrency (if they actually worked).
The alternative of holding it in actual cash, comes with security costs, storage costs,... The negative interest rate is still cheaper then the 1% annual cost of securing banknotes. It also puts an implicit floor on how low the central bank can lower the interest.
Counterparty risk dominates, for most treasurers. You don’t want your billions of corporate deposits in the bank that went bust. Treasuries—or their local equivalent—are a safe way to hold cash.
What DC scheme wouldn't let you put say 100% in shares?
Or if not you could take the currency risk on yourself, and buy US shares.
Want to take? That's an interesting question. I would contend that if bonds are yielding 0.08%, they're probably overpriced and thus too risky to buy.
I say that as some one 100% in equity with a long time to retirement, so to each their own.
I'm looking at it from the point of view of fund managers. If the fund promises to invest 50% in bonds then someone's job will be to find suitable bonds.
If you're young and you are free to choose how you want to save for your pension then I agree that stocks are probably safer. Perhaps even if the whole world slowly turns into Japan.
And state pension schemes are not usually investment based at all. They are usually funded by current social security contributions and taxes. If they go bankrupt it's for political reasons.
More likely than bankruptcy is that many people will receive lower pensions than they had hoped for.
I don't think anyone assumes the opposite, that the EUR will rise as a result of strong economics performance.
I don't find it exactly reassuring if everyone is already thinking the same thing.
Of course the picture gets a little murkier once you start considering inflation caused by exchange rate fluctuations. But that is probably not the main concern in a large currency area with an independent central bank.
Is the issue that there is loads of money in the system with not enough productive and/or low risk opportunities to invest it, so people are basically wiling to accept close to a zero return?
As a lucky owner of a luctrative bund, why would you sell it €100 on the market? In less than a millisecond, you could find people that would happily buy it €104.1 and get almost all their money back, guaranteed, at the end of the year.
As a client, you are as likely to find a fool that will sell a €104 check from the German treasury for less than €104 as to find a fool selling a €100 banknote for less than €100 (actually, the latter is more likely, for liquidity reasons).
The 1 year bond is yielding -0.1%. The 10 year bond is yielding more (-0.096%).
If 100'000 € bills existed, would founds etc. get those instead?
Is there a tax on cash or something.
Finance always seems like a big scam to me. It doesn't make any sense and the truth is protected by a guild of banksters under layers of complex hard to access rules and what not.
I'm feeling scammed when I'm buying stock with a 30 min delay on pricing and orders becouse I'm not hooked up to the really expansive investor network.
I'm feeling scammed when I can't buy real estate obligations directly but have to indirectly buy it via some expensive fund.
I'm feeling scammed when Master Card charges x.x% of every transaction I do with my bank card and it doesn't even show up on the recipe.
But maybe it's just me. It's not really a scam since I know I'm being scammed, than it's just business I guess.
Everything you pointed to is a transaction cost (or, equivalently, a limitation to reduce the number of actors to a manageable number). You're paying for the work to make that thing happen.
And, thank god, financial and medical industries are largely precluded from offering free services (a la Google) in exchange for selling every scrap of your data.
A 2% card fee is 24 minutes off a 40h work week spending half your wage with card. It's like going to the physical bank and withdrawing money saves you time if you are near by anyways (pretending the card fee was added to the recipes as a cost).
If you make 1000 USD a week, that's 10 USD or having 20 letters sent all over the country being delivered by hand every week.
Card purchases are not being manually reviewed by the bank anymore like the old photo copy ones, but we still pay for it.
It's just insane how this arcaic system prevails and how much profit can be squeezed out off it.
I guess with card fee's the main problem is that the consumer is not paying it directly, and the companys don't have the guts to openly put the cost on the consumer.
So I think your intuition that the fees aren't linked directly and proportionally to services is correct, but that's true of all businesses and it doesn't mean the profits are unreasonable overall.
Credit cards, at least in the US, rebate up to 2% or so of fees back to some customers, so they aren't charging all that much for their services.
Credit unions and banks that I've dealt with provide basic services like checking for the price of the float on your deposits, which has to be extremely small these days.
Something. It is far from trivial to store significant amounts of cash. If it gets stolen, lost or destroyed, you basically have lost your money. Also, significant amounts of cash are not that liquid anymore. It takes time to get that from your vault and deposit that to a bank. Cash is just a pain in the ass in many ways.
Having a treasury bond nowadays is the same as having money on a bank account, it's just a line of credit written somewhere, the huge difference is that if the organism recording the line of credit (a broker, for instance) fails, you still own your bund.
Why make the fuzz and having bunds in the first place and not just have the Central Bank offer accounts with a card connected? The bund system seems like an arcaic paper thing that made sense 40 years ago.
10 year bonds yield just over zero. 5 years and lower yield even less than zero:
https://www.bloomberg.com/markets/rates-bonds/government-bon...
https://www.ecb.europa.eu/stats/financial_markets_and_intere...
So effectively all the old bonds turn into new bonds, all linked to the same yield. This is why yields can be negative, it’s not like a negative yield bonds means you are paying someone. It just means that the price is so high the effective return is negative (remember that you get the face value of bond back after it matures)
One exception to this rule is newly issued bonds. Because of regulations and rules, some institutional investors must buy bonds direct from the treasury. This means that they often trade a premium (they have a lower yield) compared to old bonds.
Bonds can be a little counterintuitive because when bond prices go up, yields go down. So negative yields actually mean that market is very bullish.
You might then ask, why would anyone purchase a negative yield bond? Well, there are a couple different reasons: a) they have to, due regulations or internal rules. b) they are speculating on interest rates or currency. Or c) they are speculating on the bond market (related to b).
Bonds can be complicated because they have exposure to a lot of factors: rates, inflation, equities, debt, etc. But they are useful instruments because they have intrinsic value: they simply pay a fixed coupon and then the principal after N-years.
d) they expect them to go down even further
This is a good example, graphed: https://www.google.com/search?tbm=fin&q=MUTF:+VBMFX&stick=H4...
Bonds Summarized:
a) are less volatile compared to equities
b) provide consistent and guaranteed returns, albeit at a lower rate compared to equities
c) often work counter to market cycles: when interest rates rise, bonds fall in value, and when interest rates are cut, bonds rise. Depending on the depth of the fund, you may not see any changes at all.
Generally speaking, stocks almost always perform significantly better than bonds over long periods. If you can handle the risk, in theory 100% stocks is a better investment. Bonds provide the "don't freak out and sell" part of your portfolio.
a) Bonds, as you said, were traditional seem as counter cyclical, when equities or rates went up, bonds went down, and vice-versa. Nowadays, it seems like this might not be true anymore. So much money is pouring into the US securities market that both often now move in tandem. In the past, in risk-off environments (when you want to lower your risk), investors would move out of equities and into bonds. But now, since so much money is foreign, you see outflows from both bonds and stocks is a risk-off environment. This makes bonds a worse hedge today against equities than in the past.
b) It's true that 100% stocks almost always outperforms 100% bonds. But things get really interesting when you consider a mix of equities and bonds. Take an 100% equities portfolio of say 10 stocks: do a simulation in which you vary the weights of each position (the percentage of each stock that makes up your portfolio). Now graph the historical returns on Y axis and the historical volatility of all these simulated portfolios. What you'll see is called the "Markowitz Bullet"[1] The efficient frontier (EF), is all the portfolios that have the best risk adjusted returns (also known as the Sharpe ratio). Basically what that means is that those portfolios on the EF (the top "edge" of the bullet) have better risk/reward characteristics than any of the portfolios below them. so with a 100% equities portfolio, the best you can do to maximize your Sharpe ratio will be on the top edge of the curve.
Now consider mixing in some bonds which are at the risk-free rate. 3 month US T-notes are traditionally considered to be the risk-free rate. That is, they have no volatility and a fixed return (say 2%).
By adjusting your allocation of risk-free bonds and equities you can achieve a better Sharpe ratio than anything you could do with just equities alone. So now, with adding bonds, you can now beat the EF. The EF is now the line drawn between the risk-free point (0 variance, 2% returns) and tangent portfolio (the highest point on the curve). Check out the picture below for an illustration.
But it gets even better! If you can borrow at the risk free rate, you can now your leverage returns (but also volatility) into outer space!
Modern portfolio theory is based on this concept that adding the risk-free rate to your portfolio can actually make you achieve better risk-adjusted returns than you otherwise could with just equities alone. Seems pretty magical when you think about it (though it's predicated on the original sin of finance: that the risk-free rate actually exists)
https://en.wikipedia.org/wiki/Modern_portfolio_theory#/media...
If you've got a billion dollars/euros to manage, and assuming you can't just stuff notes in a mattress and hope silverfish don't eat them, you also can't just dump it in consumer-grade investments (typical bank insurance wouldn't cover most of it if the bank collapsed). Virtually any combination of stock/bond/tangible/land market investments, no matter how diverse, has non-trivial risk of significant loss over some time horizon.
In contrast, the most premier government bonds (US, German, maybe Japanese and/or Canadian) have a huge "too big to fail" factor. If those suddenly lose 30% of their value, it probably means the world a a whole has far bigger problems than your investment portfolio.
If your goal is asset preservation above all else, it's worth eating a known, predictable zero or negative rates of return on those bonds, as a safe harbor from the much bigger risks of the broader market.
What you are quoting is the coupon, not the yield. What this means is that back then if you bought 100 worth of the bond, you'd get a promise from the government to give you 4 back each year, plus the principal when the bond matured.
It is not quite the same as the yield.
Now consider if later a bond came out that paid 8 each year per 100 that you invested. The ones that pay 4 are still around. What would happen?
Well you would be able to buy the old 4 coupon bonds at 50 from the old buyers (the government will still give you 100 at the end). That is the price that makes the yield the same.
Why is this the case? Why don't the people who bought the 4s simply insist on getting 100 for their bonds? Because if they did, everyone would just spend their 100 EUR on the 8s. And that would continue to be the smartest thing to do until the 4s yielded the same as the 8s.
Simplified a bit, so no convexity, term premium, on-the-run premium, repo rate, futures, basis and so on. But worth googling if you're interested.
Bonds are one of the safest instruments and often pension funds are legally obligated to invest at least a proportion of funds in safe, not risky instruments.
This will not end well IMO.
https://www.bloomberg.com/opinion/articles/2018-07-10/corpor...