Negative Bond Yields In ETFs

March 02, 2015

Let’s get one thing clear: Negative bond yields are bizarre. As “things you have to explain at cocktail parties go,” it makes explaining the money supply seem like kindergarten.


And yet negative bond yields are a real thing. The number changes every day as the prices of low-yielding bonds fluctuate, but somewhere on the order of $3 trillion in bonds is currently in negative territory.


How Does This Even Happen?

Well, when an issuer like a company or government wants to sell bonds, it’s just a supply and demand problem. If, say, Germany wants to float some bonds, it’ll seek to pay as low a coupon on each bond as it can. Investors, on the other hand, rationally will seek the highest coupon they can get.


This all shakes out in the market through an auction, where people bid on the new debt the issuer is offering.


So how do things go negative? Well, first off, to my knowledge, there is no such instrument as a bond with an actual negative coupon payment. You can’t buy a bond for $100 and then mail the Bundesbank a check every quarter.


Going Negative

Instead what happens is the Bundesbank says, “Here’s a bond that will be worth $100 in five years when we pay it back. It pays nothing. How much will you buy it from us for?” In other words, it’s a zero coupon bond.


Now the market jumps in and says, “I’ll buy it for $101!” and voila, you have negative yields. You’ve just guaranteed a repayment of $100 for the low, low price of $101.


Of course, because governments are issuing bonds all the time, the implied yield of all the bonds that just happen to come due in five years will reflect that behavior, which is why bonds are almost always quoted in the press simply by their yield, not their par values and coupon payments.


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