The Swiss 10-year yield fell (meaning prices rose) 0.02 percentage points this morning, touching minus 0.41 per cent, breaking the previous record low of minus 0.39 per cent it hit last week.
Pointer from Tyler Cowen.
Why would I not rather hold Swiss currency than Swiss bonds? Currency would seem to be just as safe, and it does not earn a negative interest rate. Some possibilities:
1. There is a “convenience yield” from holding bonds. If you want to store a lot of wealth, currency is bulky and more easily stolen. So very wealthy individuals and large institutions are willing to hold bonds, even though they yield less than currency.
2. There is a bond bubble. That is, everyone knows that eventually bond prices have to fall (meaning that the interest rate rises), but momentum traders are willing to bet that in the near term bond prices will rise (meaning that rates will fall further). They think that when they buy bonds they will make a short-term profit by selling to the next sucker.
Neither of these stories is persuasive to me, but if I were forced to choose, I would pick (2).
Since writing the above, I came across Scott Sumner’s useful thoughts. He writes,
I recall reading that the SNB was informally discouraging currency use, by telling banks not to pay out large sums of currency to depositors. (Unfortunately I forgot where I read that.) Of course the US government has been trying to criminalize the use of significant sums of currency.
I still think it’s a bond bubble. I personally believe that the odds are that we will see positive interest rates a few years from now, and the people buying medium- and long-term bonds today will get burned.
I’m more inclined to see the answer as primarily 1), combined with deflation in Switzerland, though I’m sure 2) plays a role as well.
If I want to park 1 billion CHF somewhere safe, there aren’t a lot of options. I’m not even sure where I would go for storage options, equities are volatile, commodities are volatile, real estate isn’t liquid and may fall in value, etc. I’m actually not even sure if it would be possible to obtain 1 billion CHF in physical currency. Presumably a bank isn’t going to give you a better deal on a 1 billion CHF deposit either.
Since the price level is falling, and (potentially, not an expert on Swiss taxes) the interest “income” can be written off one’s taxes, -41bps of yield isn’t that much of a burden.
I can’t read FT articles. Is it just Switzerland? Maybe the negative rate is just the price you pay the Swiss government for avoiding taxes elsewhere.
Aren’t there large captive holders of government bonds, like insurers and pension plans? Add that to (2), and you have your answer- the traders already know who the next sucker is.
This is about matter of degree rather than kind. US Treasuries (short) have sold at (very mildly) negative interest rates at various points since 2008.
In addition to #1 and #2, there’s a #3.
#3 – Personal and household physical hazards from holding currency (or any other bearer instrument) versus registered book instruments.
Where I live (the Pacific Northwest) virtuall all “home invasions” are criminal “raids on currency” and seem to involve high rates of shootings and beatings. So while a very stout safe might keep $1million USD in currency from being stolen, it won’t keep hoods from shooting your dog, beating you, and setting your house on fire in a failed attempt to get it. Book entry bonds do not bring this hazard upon one’s household. (Gold, bearer bonds, stashes of contraband such as drugs, also bring this hazard with them.)
I think there’s more to #1 than “convenience”.
I’ll call it “pinning”.
Think of the bond as a Thing rather than in investment. It is not bought for its own return. It is bought to use as collateral with some counterparty, to meet some flavor of reserv requirement (think operating company loan convenant rather than bank), as insurance against certain kinds of events. In all of these cases, currency might not be acceptable – because the counterparty doesn’t want to count paper bills nor deal with fakery.
So, not just banks and mutal funds etc., but LOTs of entites may have an implicit or explicit requirement to use government bonds as cash.
Many such entities will be required to US Treasuries in the role, regardless of their yield. One presumes some set of entities face a similar requirement with respect to Swiss bonds.
So it’s not so much “convenience yield” as a “pinned to this type of instrument” market.
There is a lot more to convenient yield than just bulk. Currency in bank accounts can also face negative yields in the form of fees, while in large amounts, currency is not just bulky, but less liquid in terms of financial transactions due to transport/transfer/counting/storage/retrieval.
If banks are paying negative interest on Swiss-franc deposits too, then the problem really could be the practical and regulatory trouble dealing with large amounts of cash.
Relatedly, maybe it’s not possible to maintain digital deposits of Swiss franc currency and conduct transactions in them in as politically desirable and obscured a way as with internationally-traded Swiss bonds.
So, for example, the Chinese didn’t always immediately ‘sterilize’ their dollar surplus by buying bonds directly from the Treasury. Sometimes they would shuffle them through UK-affiliated banking houses, and sometimes through intermediaries or proxies too, to be more discrete about it and not have the totals show up in their “Major Foreign Holders” account.
That would allow them to trade Swiss bonds through brokerages that never come under the direct control of the Swiss government, unlike Swiss bank accounts. That might be like a ‘convenience fee’ – it might be worth a little negative nominal rate of return.
If cash-averse entities, parties with similar interests to my hypothetical China, and mandatory buyers (i.e. Swiss banks and institutions) form a large enough share of the market for the bonds, then it could easily push rates negative.
JP Koning has lots of interesting things to say about this, here for example.
I personally believe that the odds are that we will see positive interest rates a few years from now…
How long will ZIRP last and how high will positive interest rates occur? Who would have thought ZIRP would have lasted 7 years and there is no inflation in sight. (Even oil fell during the last 15 months.) So who is going to borrow more money? I would bet $1 that the US Fed rate is still below 2% in 2017. (Assuming no declaration of war.)
I still hold the long term effects of the Developed World (& China) Baby Bust the last 25 years is having much more Macroeconomic impacts than we thought it would have.
“I personally believe… that we will see positive interest rates a few years from now, and the people buying medium- and long-term bonds today will get burned.”
If you really believed that, you would be short Swiss bond futures. Are you? If not, why not?
There isn’t enough currency to sop up the demand. In the US there’s $1.2T of currency, versus $18T of federal debt. Of course there are other options as well (gold, etc.), but it could happen here.
If you need to park some money for a period of time and want deposit insurance you might be willing to take a negative interest rate to get it. Also note that some central banks in Europe are charging banks for holding reserves (a negative interest rate.) If those banks pass that cost on to their large depositors, a negative interest rate government bond looks like a reasonably good deal.
In addition to all the above, consider the immense force of habit.
I don’t think anyone has mentioned carry. If your cost of (term) funding is below the yield on the bond, this is a positive carry trade. The level of yield (and even the sign) don’t determine the profitability of the trade.
Couldn’t you just buy currency rather than a negative yield bond for an even larger spread? And with less risk?