Last week, we saw another landmark hit in our topsy-turvy world of money printing.
On Wednesday, the Swiss government became the first government in the world (according to several reports, at least) to have investors clamouring to pay it for the privilege of lending it money over ten years.
The bonds – which pay the lender back in July 2025 – sold at a yield of -0.055%. So if you bought the bond on Wednesday, and you hold it until maturity, then you’ll get back less than you loaned the Swiss in the first place.
It sounds crazy.
It is crazy.
But while central banks keep churning out money, things could get a whole lot crazier.
Why would anyone want to buy a bond with a negative yield?
Strange as it may seem, there are many logical reasons for ten-year Swiss bonds to still be attractive to investors, even at negative interest rates.
For a start, the Swiss economy is in deflation. In the year to March, Swiss prices fell by 0.9%. In other words, they’re in the unusual situation where £100 today will actually be worth more in a year’s time, rather than less. So if you’re a Swiss saver, then you can still get a ‘real’ (after deflation) return on your money as long as your savings shrink at a slower rate than prices.
In the case of the ten-year bonds, a -0.055% yield doesn’t look quite as bad if you realise that it’s a positive ‘real’ return – assuming deflation continues at current levels or gets worse.
Secondly, if deflation does get worse, other investors might be willing to accept an even more negative yield. So you could probably sell the ten-year bond in the secondary market for a higher price than you paid for it.
Thirdly, there’s the reason behind the Swiss economy being in deflation. It’s mainly because the Swiss have thrown in the towel in the currency wars. They gave up printing money to keep the Swiss franc down against the euro when they realised that the European Central Bank (ECB) was about to start printing.
It was a fight the Swiss couldn’t hope to win. They were going to be flooded with money fleeing the euro, and it would have been costly for the Swiss central bank to try to counter that. As a result, the Swiss franc is now one of the world’s stronger currencies. And that also increases demand from overseas investors for Swiss franc assets – despite efforts to put them off.
So there you go – three logical reasons to buy Swiss bonds on negative yields.
Of course there’s a problem here. And that’s the fact that these logical reasons are founded on us continuing to live in an utterly insane world.
This is all dependent on central banks continuing to print money
You see, all of the reasons for Swiss bonds trading at negative yields boil down to one thing – central banks printing money to artificially suppress their currencies and interest rates.
Even when Japan was mired in the worst of its deflation, its ten-year bonds never went negative. So this isn’t about the economic backdrop – it’s about market mania.
Steven Major, a fixed income (that’s another name for bonds) expert at HSBC, put it very well in the FT. “We have unconventional central bank policies at work so you have to expect unconventional outcomes. One is that bonds are no longer trading like bonds. They now trade like commodities – with investors speculating on price.”
Now if you’ve been a reader of Money Morning for a while, you might remember that we don’t tend to think of commodities as a traditional investment. That’s because they don’t generate an income (or at least not in the way that a company or rental property does). So if you buy a commodity, you’re betting that the price will go higher in the future. You’re taking a punt, basically.
I see gold as different from other commodities – it’s a useful form of insurance against financial instability – but this criticism is often directed at the yellow metal too. It doesn’t pay an income. In fact, you have to pay to hold it.
But as Major notes, you can now say the same thing for bonds. You have to pay to hold them.
I’ve held up the Swiss as the key example here, but bonds with negative yields are everywhere. The FT describes them as “one of the world’s fastest-growing asset classes”. As Reuters notes, Swedish and Danish bonds are trading hands on negative yields “out to about five years”.
How to invest in this topsy-turvy world
Clearly this can continue while central banks keep printing money. But I have a couple of concerns about this. Firstly, the Federal Reserve is at least thinking about raising interest rates. It’ll be interesting to see how the rest of the bond market reacts to that.
Secondly – and this is rather more old-fashioned thinking – I don’t like the idea of investing in an over-valued sector just because it has momentum behind it.
So I’d favour equities over bonds. They’re arguably not as overvalued. If you’re an income seeker, you can still benefit from decent dividend yields. And shares in Europe and Japan in particular will also benefit from money printing. Yes, there’s more risk to your capital, but the risk of capital loss on bonds (non-government ones certainly) has got to be growing too.
And hang on to some gold. If you’re going to own an asset with a negative yield, it might as well be one that has absolutely no bankruptcy risk, even although its capital value may be volatile. If the bond market supercycle comes to a nasty end, gold is likely to benefit in the ensuing havoc.
You can learn more about the potential risks from government debt and deflation in my colleague Tim Price’s latest take on Europe – if you haven’t read it already, you should take a look at it here.• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.