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  • Christian Armbruester

Dumb and Dumber

More than $14 trillion of government bonds now have negative yields. That’s equivalent to one quarter of the entire global investment grade market. Yet, during the months of July and August, these very bonds surged, outperforming equities on a large scale. Clearly, there was a flight to safe havens as equites came under pressure as a result of the on-going trade dispute between the US and China. Furthermore, the decision by the US to lower interest rates had a knock-on effect, and expectations increased for further rate cuts in the Eurozone. But why would anyone pay someone else to lend them money and can interest rates keep going down forever?

The simple answer is no, and all you have to do is look at the math: the 10-year Swiss bond is now yielding negative 1%. That means, if we hold these bonds to maturity, we will owe the government 10.46% (thanks to compounding). That may be acceptable to those that crave liquidity above all else, but could you also justify doing this, if rates were to go to, say, negative 2%? Yup, that means we would be paying the government 21.89% for the privilege of lending them money. Clearly, there comes a point when anything is better than losing too much money.

Equities, property, venture capital, private equity, private lending and even those much-maligned hedge funds that produce alpha – all of them at least offer a chance of actually making money. Heck, we could even decide to go to the casino and give it go, anything other than flushing money down the toilet. So, who is buying this stuff then? Central banks may buy debt with negative yields to support markets and pension funds may be forced to buy any local government bonds as a matter of regulations. Then there are the speculators, who are taking a view on trends or market events. But it is a dangerous game indeed and lest we forget, that which goes up, can also come down.

Common perception is that government bonds offer protection when markets come under duress. Absolutely, and this is what we have seen in many a crisis, particularly in 2008 when government debt spiked as equities fell. The problem is, this effect is only very short lived and the minute the panic abates, all of the so-called safe haven investments fall like a rock. In other words, if you are buying government debt with negative yields, because you are afraid that markets may fall, you have to also get your exit right. Otherwise you will incur heavy losses. Good luck with that, and if you think you can time the markets, then you might as well just wait and buy the bottom.


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