What do negative yield bonds and cryptocurrencies have to do with one another? If this isn’t your first rodeo, then you know that there is more to investment strategies than just socking away money for a rainy day.
What really counts when it comes to keeping the economy going, as well as seeing your investments grow, are interest rates. And by lending money, both individual investors and nations can benefit from returns from interest.
Bonds are a way of ensuring that there is liquidity in a nation’s economy, as it incentivizes individuals and institutions alike to buy into them. And when anyone buys a bond, they are lending the government money to build essential infrastructure, like schools and roads.
So what are negative yield bonds? And how does this affect the value of cryptocurrency? The basic belief is that while bonds are in low and negative yields world-wide, crypto markets offer the investor more immediate value.
In 2019 Bitcoin returned to a bull market, with its value on a continued upswing. And while Bitcoin was lighting up the crypto-market, so gold has also made a comeback.
The basic idea is that investors are not seeing strong returns on your traditional institutional investments, as is the case with bonds. So, in place of the missing liquidity, cryptocurrencies are gold are enjoying a bit of a heyday.
But let’s go back a bit, and take a look at what all of this means, negative yields and low-interest rates.
This article talks about the importance of interest rates and portfolio diversification. In order to do this, we will go through:
- Negative and Zero Yield Bonds
- Sovereign Debt
- The Basis Swap
- Liquidity in Cryptocurrencies
Why Investors Buy Negative Yielding Bonds
In order for central banks, insurance companies and pension funds to maintain liquidity, they must hold bonds, even if they have negative returns. Bonds are used to maintaining liquidity and also work as collateral.
As such, in 2016 an estimated 30% of the global government bond market. This includes a certain amount of corporate bonds, which are traded at a negative yield.
This is because Investors will buy bonds for more than face value, and then lose money on the bond, which means it has a negative yield. This happens when the total amount is of interest in investor earns from the lifetime the bond is less than the premium paid for the bond.
The reason for this is that investors need reliable liquidity of a government bond and in some cases a high-quality corporate bond. Therefore, large investors such as pension funds, insurers, and financial institutions are sometimes willing to take the loss because they have few other safe places to store wealth.
Foreign and Domestic
By investing in domestic and foreign currencies, investors, particularly large pension funds or hedge funds, secure or back their assets by investing in negative yields bonds. The basic principle is that it helps to keep liquidity in the market. Which is seen as an overall benefit.
As another example, it may be that Germany’s or Britan’s economy is currently in a deflationary period. That means that the economy is a slow and the Euro and Pound are not as strong.
However, it is a good bet that these economies will recover in a reasonable time-frame. And in the meantime, they benefit from the basis swap (which I will explain shortly). They have before as they have strong well-rounded economies, and so it is reasonable to expect that their currencies will return stronger.
So, foreign investors might believe the currency will rise. This will have the effect of offsetting the negative bond yield. And domestically, if a deflationary period is expected, then investors make money through using their savings to buy more goods and services.
Finally, investors might be interested in negative bond yields if the loss is less than it would from other assets classes.
Fewer Negative Yielding Bonds
It might seem strange, but negative yield bonds are a part of today’s economy. That’s right, our economies function on debt and interest rates. These debts and interest are shared between trading economies.
Whatever you might think about the principle of carrying so much debt, the debt that nations take on is also responsible for the subsequent growth rates. This is because, when done responsibly, these debts are made in order to invest in lucrative projects which turn into more money.
However, as we saw in 2008 in the United States mortgage crisis, debt was not used responsibly. It was in part the institutionalized irresponsibility and acceptance of debt that inspired Satoshi Nakamoto to create Bitcoin.
But, in better news for the traditional markets, as of 2018 as many as $1 trillion bonds left the negative yield zone, decreasing the sub-zero yields to $7.3 trillion. This decrease in sub-zero yields indicates an increase in growth and inflation. The normalization of rates is the result of factories attempting to keep up with the demands of a worldwide market.
Understanding Debt and Negative Interest Rates
Low-Interest Rates and Economic Growth
Low bond yields are the result of low-interest rates. Lowering interest rates is a strategy that monetary authorities use to intense borrowing and economic growth. By introducing negative yield rates central banks are able to charge other smaller banks to hold money.
After several European nations adopted zero interest rates, the Bank of Japan soon followed suit. This is known and “quantitative easing,” where central banks push down interest rates by purchasing longer-term debt.
When you invest in bonds, you are loaning the issuing government money. Bonds are primarily used in the United States, Sweden, and Switzerland. Other countries like Germany and Canada used to use them, but were primarily used to rebuild after World War I and II. Since then they have been replaced by other institutional and government savings and investment projects that are slightly more lucrative for countries like Canada and Germany that have smaller populations.
But, back to bonds and sovereign debt. Sovereign debt is the debt that a government has to those they sell bonds to. Bonds allow the government to borrow money from investors, and the investors are paid interest earnings in return.
There is a difference between government debt and sovereign debt. Government debt is issued in the domestic currency, while sovereign debt is issued in a foreign currency. So it is the exchange of debts and mutual investment that many believe justify and prove the value of negative yield bonds.
The Negatives of Negative Interest
Advocates of negative yields argue that they help to boost central banks, which are foundational to the economy.
However, many European nations are carrying zero-interest bonds, including:
- Swedish and French 10-year yield bonds
- Switzerland’s bonds have negative yields
- Germany has eliminated its bonds, and while honoring its bonds no longer issues them
What does this mean? In short, it will affect your investments in bonds in the short-term. That means that if your pension fund is holding bonds, which they likely are, then you will see very little growth at this time. However, they are still seen as a necessary part of your portfolio. This is because bonds supply liquidity.
Negative yields further emphasize the importance of diversifying your portfolio.
While interest rates are low, and returns are low, cryptocurrencies like Bitcoin and Ethereum, as well as precious metals like gold and silver, are going strong. This is likely because, amidst negative yields, investors are looking for liquidity and security in other markets.
Basis Rate Swap
One reason that negative yield bonds are still used is “the basis swap.”
A basis swap is a way to hedge risks, by invest in higher-yielding assets. Global investments include using basis swaps. This is because negative-yielding assets can turn into valuable assets.
Basically, one institution exchanges one floating interest rate for another. In doing so the two currencies exchange liquidity. And so the interest earnings are now based on two different floating rates. This provides both institutions with liquidity.
Basis swaps are primarily done by large institutional clients with large trades. This kind of swap allows investors to hedge their assets and liabilities from their own currency fluctuations by investing in another currency. This is what Japan does, and in doing so, creates stability for the value of its own currency.
It is hard to say exactly what to think of negative yield bonds. The basic principle is that if you are investing in a strong economy with a stable government then your money will grow. So low-interest rates and yields are basically part of the cycle of the economy.
The thing to be concerned with is the diversification of asset classes. Bulls and bears are a part of the normal environment of the market. But it is probably time to include a few strong cryptocurrencies in your portfolio.