Wednesday marked a key moment for the German 10-year government bonds (or bunds as they are known). While they have been trading at negative yields for a while now, it was the first time that a new Bund was issued at a negative yield. This implies that investors now effectively pay Germany to borrow their money.
Yields continue to plummet in key markets as investors pile into government debt. This comes in the wake of a slowdown in global economic growth, low inflation and increasing uncertainty. Switzerland for example, having issued 10-year debt at negative yields back in April 2015, also issued debt at negative yields yesterday however this time for a bond maturing in 2058.
Today, the Bank of England (BoE) unexpectedly held interest rates at 0.5% while keeping the door open to a reduction later on in the summer, to a new record low. This would be the first change in BoE’s key interest rate since March 2009 when it was cut to its present level following the financial crisis. The BoE is hoping to provide what it sees as a necessary boost to the economy as a result of the uncertainty caused by the U.K.’s decision to leave the EU on June 23, 2016.
In total, there is now over $13 trillion of negative yielding debt globally, according to Bank of America Merrill Lynch. Central banks have been the key drivers behind this as they have cut rates in an effort to stimulate their respective economies in the face of slow economic growth and continued prospects of low or even negative inflation (i.e. deflation).
While negative interest rates might seem counterintuitive to the average consumer, there are valid reasons why investors may choose to lend their money. In effect, investors are betting that interest rates (and yields) will continue to fall and therefore increase the value of the debt they currently hold (price and yield have an inverse relationship). This essentially allows them to realise a profit before the debt matures.
With regards to the economy, there are two primary benefits to low interest rates. Firstly, this will allow governments (along with corporations and households) to refinance their debt at lower levels. Secondly, it means that governments, corporations and households can borrow money at cheaper levels to finance transactions, such as building a factory or buying a home, which in turn boosts economic growth.
Conversely, there are key risks to prolonged periods of low interest rates. In the past, this has caused asset bubbles and extremely large debt burdens, which may eventually become unsustainable and lead to a widespread correction. It is difficult to predict how much lower yields will go or how much longer they can remain at these record lows. However central banks, including the Bank of England’s Governor Mark Carney (pictured above), have sought to reassure investors that a “host of other measure and policies” are available to support the economy.