Crazy European Bond Market

[Running_Man]

Assuming this negative interest rate contagion will spread to the USA markets. What is actionable that one can do?
1. Buy original purchase TIPS (so you at least get your principal)?
2. By really long CD's or BONDS now?
3. Lower Bond allocation (hate to change based on "timing the market")?

What is actionable?

OK if you assume US treasuries are going negative you buy 30 year bonds. German 30 year Bonds are up 25% YTD with rates going from 0.87% to -0.129, this is why a mania develops to buy long term bonds. German Bunds at 30 years and negative rates have earned a greater return than the S&P500 this year. At the present time US 30 year treasuries are 0.05% away from their all time low. Almost every other major company are at all time lows for their interest rates. New Zealand cut rates 1/2 point last night because their currency was getting too strong. The FED did not realize what they needed to do when they cut only 1/4 point.

 

[dixter]

even more fun this morning...
https://www.cnbc.com/2019/08/07/us-treasury-bonds-china-sets-the-yuan-below-expectations.html

 

[dixter]

what is actionable ... I don't think the foreign bonds are the correct instruments for individual investors... those are for the central bank boys to handle... but interest rates gong down affect ALL bonds... so an action in the bond market is corporate bonds where you need to be informed of the actual bond price, the duration, the coupon rate, is it callable ...ect..ect... if you buy a corporate bond today... and interest rates go further down then the bond value (what it costs to purchase) is going to go up.... so if hold that bond then you can sell the bond and get the difference in the price you paid today and how much you sell it for when the interest rates dropped... and of course during the time frame you hold the bond you also get to keep the accumulated coupon interest at the time of sell... so is there money to be made... sure there is... its almost a given the way the bond market is working right now...

 

[Running_Man]

https://www.msn.com/en-us/money/news/20-year-mortgages-hit-zero-for-first-time-in-danish-rate-history/ar-AAFtb2Z

And now in Denmark you can get a mortgage with a -0.5% interest rate! Yes the bank will pay the seller full price and you can pay back less than the bank paid. Instead of paying $965 a month on a 100K 3% loan 10 year loan you can pay $812 a month for 10 years, saving 2.6% in principal over the course of the loan.

 

[Markola]

End times for the cycle are probably near when this kind of Bizarro World stuff happens. Remember how “negative earnings are good for tech stocks” was the belief circa 1998? How no proof of income was needed for mortgages circa 2007? Now there are mortgages that pay the borrower. Gimmeabreak. The sewage is building up behind the dam.

 

[NW-Bound]

^^^ It is worrisome, isn't it?

I remember that in 1999-2000, people talked about the New Economy, where you did not need old-fashioned brick-and-mortar businesses, and a lot of things could be done cheaper by high-tech companies via the Internet. Later, it turned out that service companies still need hard assets, such as Amazon's warehouses, Google and Netflix server farms, etc...

I don't think anyone knows how this negative interest rate is going to end. It cannot be good. It is not in anyone's book. Totally unprecedented.

 

[BeachOrCity]

OK if you assume US treasuries are going negative you buy 30 year bonds. German 30 year Bonds are up 25% YTD with rates going from 0.87% to -0.129, this is why a mania develops to buy long term bonds. German Bunds at 30 years and negative rates have earned a greater return than the S&P500 this year. At the present time US 30 year treasuries are 0.05% away from their all time low. Almost every other major company are at all time lows for their interest rates. New Zealand cut rates 1/2 point last night because their currency was getting too strong. The FED did not realize what they needed to do when they cut only 1/4 point.

Thanks for this and the other ideas. The more I think about this, the more I think "this will not end well". It will be almost impossible for the US to maintain its interest rate level if the rest of the developed world is negative.

 

[Running_Man]

As a for instance, I believe the Austrian 100 year bond, that was the reason for this thread is up over 20% from the start of this thread, really quite extraordinary, already 15 years interest in the last 3 weeks

 

[samclem]

OK if you assume US treasuries are going negative you buy 30 year bonds.

That'll work while rates are going down, but it does require that we know when to sell the bonds. If the US eventually elects to not to keep decreasing rates but instead increases money supply (to keep the economy moving forward), would it not be safer to be in TIPS? If the bond bubble bursts, and even if inflation returns, the TIPS will still do okay, no need for precision timing. Sell them if it seems right, or hold to maturity and at least receive par value for 'em.

 

[OldShooter]

... It will be almost impossible for the US to maintain its interest rate level if the rest of the developed world is negative.

+1 The seldom-mentioned fact is that the Fed does not operate in a vacuum. US rates that are above or below general world levels will attract or deter investment, especially the hot money that has been the bane of small country economists. For us, the hot money is less of a problem, but a strong dollar is. Like a stopped clock that is right twice a day, Trump is right on this one. A weaker dollar will increase US exports and deter imports. Over a longer period, it should also increase investment in US manufacturing capacity, though that investment may come from overseas.

 

[OldShooter]

That'll work while rates are going down, but it does require that we know when to sell the bonds. If the US eventually elects to not to keep decreasing rates but instead increases money supply (to keep the economy moving forward), would it not be safer to be in TIPS? If the bond bubble bursts, and even if inflation returns, the TIPS will still do okay, no need for precision timing. Sell them if it seems right, or hold to maturity and at least receive par value for 'em.

Yup. IMO TIPS are very good insurance and giving up a little bit of current yield is simply an insurance premium payment. We have maybe 15-20% of our portfolio in TIPS and have never bought any kind of long bond, despite the face that DW used to manage a retail bond sales department at her megabank.

 

[samclem]

Yup. IMO TIPS are very good insurance and giving up a little bit of current yield is simply an insurance premium payment. We have maybe 15-20% of our portfolio in TIPS and have never bought any kind of long bond, despite the face that DW used to manage a retail bond sales department at her megabank.

How did you integrate them with the rest of your holdings? I have a very rudimentary understanding of TIPS, but the approaches that occur to me:
1) Build a TIPS ladder for income. Each year's income comes from one bond that matures that year plus all the coupons received for the bonds that will mature in subsequent years. This is a good way to assure up to 30 years of a steady baseline flow of inflation-adjusted income, but it stops at that point. It's not a true "hedge" because there's no leverage.

2) Buy TIPS with a long time to go before maturity. If CPI-U goes high (with an expectation it would go higher) and investors can't find other solid investments to match it, then these bonds could be a a good hedge--sell them off as needed to cover shortfalls in the rest of the portfolio, and at very worst you ride them out to maturity and get your inflation-adjusted investment back.
3) Buy (original issue) TIPS with shorter maturities as insurance against deflation, hold to maturity. The + is that the Treasury pays you face value even if there has been net deflation over the time since they were issued.
4) A mix of 3 and 4 above.

In any case, they ain't sexy, but at the very worst you'll get the actual value of the investment back at maturity (maybe more in the case of deflation). While there could be a big opportunity cost for an investment in TIPS, the only way to lose actual value is if they are sold before maturity AND the expected rate on similar govt bonds is higher than the total expected yield for the TIPS being sold.

 

[Running_Man]

That'll work while rates are going down, but it does require that we know when to sell the bonds. If the US eventually elects to not to keep decreasing rates but instead increases money supply (to keep the economy moving forward), would it not be safer to be in TIPS? If the bond bubble bursts, and even if inflation returns, the TIPS will still do okay, no need for precision timing. Sell them if it seems right, or hold to maturity and at least receive par value for 'em.

The question was what do you buy if long term rates are going negative in the US with the rest of the world, and that answer is undoubtedly long term US Treasuries. YTD TLT is up about 18% TIPS about 8%, if your buying Vanguard TIPS ETF you are up about 4%.

Truth be told I sold a good percentage of my long term US bonds this week (about 1/2) on what looked to me like a panic bond buying run, and replaced them with 3-6 month treasuries to give time to sort out the market while it decides what to do, always good to have cash available when chaos occurs. If rates continue to fall I am content with the portfolio of long term bonds I have left...

Since we are as of today up another 1.3 trillion in negative bonds from the start of this thread the big idea is why are rates going negative and what is the impact to markets? This is not normal, and it occurred years after the financial crisis. This indicates it was caused by the solutions of the financial crisis and not the financial crisis itself.

The historic low interest rates is causing large capitalized companies to buy back enormous dollars of stocks at all time highs in stock valuations. It’s end will be a cash reducing recession, a decline in stock prices would follow and grave difficulties in repaying debt with the lower income if interest rates were to rise, so odds are interest rates will not rise. Companies would be forced to issue equity to raise capital funding further pressuring stock prices, as the negative side of debt would come to the fore. Downgrades in BBB would be severe and those consequences too ugly to digest, blah……..

The bond markets of the world are now too large a portion of world GDP to allow a substantial interest rate rise so one must assume the Central Bankers will keep rates low. That this is unusual does not mean it must end soon, l think it will last as long as Central Banks have the will to forge on.

On failure to hold TIPS will not be a place to hide during an implosion of debt, which would mean central banks had lost control, a dire thing so we must hope that does not occur the offset then would be gold or potentially bitcoin, though I avoid the electronic ether myself but have 8 percent of my assets in precious metals about 1/2 of the amount I presently hold in long term bonds.

 

[NW-Bound]

What bothers me is that financial institutions buy negative bonds if they can find no better place to put their money.

Why is that? What economic circumstances lead to that? I don't care for and don't want to buy negative bonds, but what drives people to do that may be something that affects me later on.

 

[OldShooter]

How did you integrate them with the rest of your holdings? ...

@samclem, I can answer your specific questions only indirectly but I will try:

More than most investments, I think the parable of the blind men and the elephant applies to TIPS. You and most others are touching the investment aspect. I am touching the insurance aspect. Here's our story:

When we retired (in our 50s) we were mostly in equities and it was our judgment that we probably had more money than we would ever need. The only risk to our retirement, we felt, was high inflation. In risk management lingo, this was a low probability, high impact risk. So the next step in risk mamagement is to look at the cost to mitigate. If the cost is low, it's a no-brainer to mitigate. For us TIPS were the answer.

In 2006, we put about 1/3 of our IRA money into one issue, the 2s of 2026. This were the longest bonds we could get and had the lowest coupon. The total amount was, we estimated, enough to inflation proof a frugal retirement if the SHTF. From that point we basically forgot about them, living our lives out of the balance of the portfolio.

Luck is frequently mistaken for skill, so when interest rates went to zero, we looked like geniuses. The TIPS were worth around 50% more than we paid. In 2011/12 we did succumb to a little greed and sold a few, but at that point we were 5+ years closer to pushing up daisies so, we rationalized, we did not need quite as big a stash.

We still have most of those TIPS, though we have started to reduce the position slightly as our planning horizon is shorter. Cost to mitigate? Really, zero. Our heirs and charities will get a little less, but they will never know it. Even if I do look at the yield hit from this strategy, I look at it as paying an insurance premium. We have fire insurance on our home, too, and pay an insurance premium on that. But buying insurance doesn't mean we want the house to burn down, nor does owning the TIPS means we are wishing for high inflation. Indeed, its the opposite in both cases.

Viewed as insurance I think the only sensible TIPS position is to have enough to protect a tolerable retirement lifestyle for the long term. Small positions in TIPS really come from an investment view of the elephant and I'm not sure they make any sense at all.

HTH and, of course, YMMV.

 

[samclem]

OldShooter, thanks for the explanation, it is very helpful.

Total return on equities has historically done a good job of keeping up during "normal" inflationary periods, so I surmise you were looking for insurance in the event of inflation above this level--when it becomes disruptive to business, capital flows to businesses, and, ultimately, to equity returns. You were not focused on buying insurance against deflation, and (I think based on your other posts) that you assessed that the Fed and Treasury have sufficient tools (helicopter drop---etc) to overcome deflation, but at the risk of creating inflation (which holding TIPS could address).

I'm not sure I know enough to discount the possibility of a prolonged period of very low (negative?) interest rates accompanied by low inflation and the falling/flat equity returns--like Japan has experienced for decades. Even with a big increase in the money supply, inflation won't escalate if there's not a concomitant increase in demand for goods/services.

 

[OldShooter]

Yes, pretty much. I really think any kind of significant deflation is at a negligible probability, and really it would result in the buying power of our portfolios increasing anyway. So it's not in my risk matrix.

Re "very low (negative?) interest rates accompanied by low inflation " no one knows the future. If such a scenario occurs, my TIPS insurance will not have been necessary. But my house has never burned either, again low probability/high impact, and I still don't regret buying the fire insurance.

 

[cyber888]

Seems like the Negative Bonds rates all over Europe will drive Cash to the United States. I think this is good for the US. If you're a global investor, I would park my money in the US than the EU, don't you agree ?

 

[NW-Bound]

A strong dollar may be godsend to American tourists, but anathema to American exporters. It will cause slower economic growth here.

 

[Running_Man]

https://www.bloomberg.com/news/articles/2019-08-12/markets-set-to-sell-off-in-argentina-after-macri-loses-primary

One of the original 100 year bonds, the IMF sponsored 8% USD Argentinian bond, this morning fell 27% in one session and is now down 50% over two years from it's issuance. Good news is it pays in USD and the yield right now is about 16%! So you only need 6 years of payments to be whole! (Ahead of the negative yielding European debt), so not all government debt is yielding zero, even if they are all crazy.

 

[OldShooter]

https://www.bloomberg.com/news/arti...ll-off-in-argentina-after-macri-loses-primary

One of the original 100 year bonds, the IMF sponsored 8% USD Argentinian bond, this morning fell 27% in one session and is now down 50% over two years from it's issuance. Good news is it pays in USD and the yield right now is about 16%! So you only need 6 years of payments to be whole! (Ahead of the negative yielding European debt), so not all government debt is yielding zero, even if they are all crazy.

Yup. And the professionals who know this bond and its market inside and out have determined its current value, so its future value will be determined by random events as yet unknown. As Dirty Harry said: "You've got to ask yourself one question. Do I feel lucky?"

 

[MichaelB]

Yup. And the professionals who know this bond and its market inside and out have determined its current value, so its future value will be determined by random events as yet unknown. As Dirty Harry said: "You've got to ask yourself one question. Do I feel lucky?"

Aren't they the same ones that determined the price when it was first issued?

 

[GrayHare]

Why not cash instead of negative-rate bonds? Ostensibly some of the negative bond rates are due to the cost of storing cash. An easy solution for the ECB is to make legal tender a large denomination note or coin, say 1 billion Euros. If storage of that note or coin is expensive as well, instead make that money solely an electronic entry.

 

[OldShooter]

Aren't they the same ones that determined the price when it was first issued?

Well, I am completely unhampered by facts but my guess is that the original issue was purchased by yield-hungry pension fund managers who were betting that a default would come after they had moved on. This despite the fact IIRC that Argentina has already defaulted on its sovereign debt many times*. I doubt that it was the professional traders that took the offering. Initial offerings are usually sold, not bought.

Also, circumstances would have been somewhat different. IIRC that offering was a couple of years ago.

*"Argentina has defaulted on its sovereign debt eight times since independence in 1816 ... " https://www.ft.com/content/5ac33abc-551b-11e7-9fed-c19e2700005f

 

[OldShooter]

Why not cash instead of negative-rate bonds? Ostensibly some of the negative bond rates are due to the cost of storing cash. An easy solution for the ECB is to make legal tender a large denomination note or coin, say 1 billion Euros. If storage of that note or coin is expensive as well, instead make that money solely an electronic entry.

You're missing the point that the goal of the negative rates is get the money spent. Central bank panjandrums are not going to help hoarding by trying to make it easier.