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Post by samford71 on Aug 21, 2019 17:58:42 GMT
Today, Germany issued a new 30-year government bond. Coupon 0.00%, current price 104.6% of par. People are lending the German government 104.6 Euros today, for precisely no interest over the next 30 years, and at the end they get back 100 Euros. A yield of -0.145%. It's actually cheaper than printing money.
Germany is flirting with recession given their dependence on Chinese infrastructure demand, which is waning as the Chinese orientate more toward domestic consumption with a growing middle class. Germany meanwhile has a total lack of domestic demand consumption and too much private saving. German government infrastructure is old. Their taxes are high. They could stimulate domestic demand by infrastructure spending and rather than sterlize this with taxation, they could cut taxes and instead issue more bonds. Bonds that that the market is crying out for given regulations that force them to own such instruments. Bonds that are needed to hedge the liabilities of pension funds and life assurers. Yet the government, running a fiscal surplus, is worried about relaxing their fiscal rules. The people running the country are old. They remember a time when inflation was still a problem and fiscal deficits were too high. They just can't get out of that mindset. They are still fighting the 1970s. They can't see that the problem is now deflation and that running a fiscal surplus is doing more harm than good.
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locutus
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Post by locutus on Aug 21, 2019 18:11:47 GMT
samford71 are you talking about the 30 year bond that redeems in 2050? According to Bloomberg, the sale was a flop.
Can you explain who would buy these bonds and for what reason? Even if you expect an upcoming global recession, surely no one thinks it will last 30 years so how can these bonds ever be a good investment choice?
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Post by samford71 on Aug 21, 2019 18:13:51 GMT
samford71 are you talking about the 30 year bond that redeems in 2050? According to Bloomberg, the sale was a flop.
Can you explain who would buy these bonds and for what reason? Even if you expect an upcoming global recession, surely no one thinks it will last 30 years so how can these bonds ever be a good investment choice?
Oops typo. Meant 30 year. Will edit. It was a flop; market thought it would go for an ever higher price!
There are a number of reasons why people buy bonds at negative yields (or even at positive nominal yield but negative real yields, once likely inflation is taken into account)
1. Many investors operate on a funded basis i.e. they borrow money to buy the asset in this case a bond. So the 10-year Germany government bond yields -0.67%. However, you can repo this bond i.e. borrow money using the bond as collateral at an even more negative rate, say -1.00%. So you can lock in a 30bp spread. That isn't very much but remember you can leverage that position.
2. You may think the price will still go higher, and the yield lower, in the short term. At the moment, for example, the market is assuming the ECB will cut another 20bp in September and restart QE. This has driven yields lower.
3. Flight to quality. The world is looking a less nice place. Economic data is pointing to a possible recession. Deflation is far more of a risk than inflation. You have China-US trade war risks, Brexit no-deal etc
4. Regulations force a number of investors to hold bonds against their liabilities (such as some pension funds and life assurers) since their liabilities are priced off the bond curve i.e. liability matching.
5. Regulation makes it often more attractive for certain investors to hold government bonds over say lending to SMEs or consumers etc. A bank does not have to hold regulatory capital against government bonds (they are 0% rated on Risk weighted asset basis). So you lend £100mm to SMEs at say 6% and use £12.5mm of working capital (since SME lending is 125% RWA) or you could buy Bunds at -0.67%, fund at -1%, and lever that 20x, earning 6.6% and using no RWA capital.
6. There is a global shortage of government bonds. The developed world's population is aging and want "safe" assets; think about all those lifestyle funds that switch from equities to bonds each year as you get older. We have QE that has taken trillions of bonds out of the system. Against that governments are obsessed by running flat or positive fiscal positions. So bond issuance has fallen in many countries. This might have made sense when Gilt yields were 10%+ in the 1980s or even 5% in the 2000s but when you can issue 50-year inflation linked Gilts at a -2.07% real yield, you should issue. Governments are showing no price sensitivity since they are wrapped up in ideology and a macroeconomic model that is still fighting the issues of the 70s/80s.
There are manys others I've left out. The market is not being irrational. It might be being too short-term but that is not unusual. To be fair, though, bond yields have been falling now for over 30-years in a secular trend. We've unwound the whole inflation scare of the 1970s and early 80s, gone through "normality" and come out on the other side. It's a dangerous point. We probably need a form of economic regime change but whether we get the right one is another question.
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jo
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Post by jo on Aug 21, 2019 18:29:38 GMT
If capital is free then interest rates are zero. Inflation noise then swamps simple interest figures. The debate should be, is it a zero capital income world or will we keep printing money forever? Who's printing money and by what method are they doing it?
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Post by Deleted on Aug 22, 2019 8:47:47 GMT
If capital is free then interest rates are zero. Inflation noise then swamps simple interest figures. The debate should be, is it a zero capital income world or will we keep printing money forever? So much for Piketty's contention that the return to capital is too high! I would contend that he is still correct. If capital generation costs nothing then paying anything above nothing is too much.
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Post by Deleted on Aug 22, 2019 8:53:11 GMT
If capital is free then interest rates are zero. Inflation noise then swamps simple interest figures. The debate should be, is it a zero capital income world or will we keep printing money forever? Who's printing money and by what method are they doing it? QE by its various forms around the world. Japan, Europe, any bond at zero or negative is a form of printing money. As the cost of capital reduces the opportunity for income from capital reduces. So P2P model falls from 12% to 9 to 6 and now 5. Then the issue becomes inflation. If inflation is greater than interest (after tax) then those with capital should spend, but they don't because they are humans rather than theoretical economists.
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jo
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Post by jo on Aug 22, 2019 9:09:17 GMT
Who's printing money and by what method are they doing it? QE by its various forms around the world. Japan, Europe, any bond at zero or negative is a form of printing money. As the cost of capital reduces the opportunity for income from capital reduces. So P2P model falls from 12% to 9 to 6 and now 5. Then the issue becomes inflation. If inflation is greater than interest (after tax) then those with capital should spend, but they don't because they are humans rather than theoretical economists. QE can rightfully be accused of causing many undesirable things but printing isn't one of them. It's simply a duration swap - long for short, no increase in absolute money supply results. This negative yield phenomenon is most likely part of a currency war race to the bottom as blocs desperately try to avoid importing deflation. The Swiss had negative rates in the 80s when their currency was amongst the strongest in the world - I paid 1% to be short of it and 1/2% to be long of it. How this current trend reverses, I have no idea.
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Post by Deleted on Aug 22, 2019 14:53:49 GMT
I agree in the race to the bottom, see earlier in thread.
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