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Investors prefer US bonds as safe investment options even though interest rates have fallen.

Will US Bond Yields Continue to Drop?ARTICLE

By Phillip Silitschanu

The world has witnessed a steady march towards lower and lower bond yields. While the occasional dip in the yield of government issued bonds is to be expected, and is rarely a significant news event for anyone but dedicated bond traders, the persistent and widespread decline of bond yields is beginning to garner the attention of businesses who would normally not be concerned with the nuances of bond markets.

The yields from government bonds issued by leading nations have been reaching new lows this year.1 One of the main reasons for the decline in bond yields is that countries in Europe, as well as Japan, have been striving to stimulate their economies by buying up their outstanding bonds, as well as implementing lower and lower interest rates.2 In fact, interest rates have steadily declined, to the point where some countries’ interest rates have approached, or reached, zero percent.3

In July, bond yields on US 10 year Treasury Notes, as well 10 year bonds from countries such as Denmark, France, Germany, the United Kingdom, Sweden and Switzerland all declined to record breaking lows; while the yield on Japan’s 20 year bond dipped to below zero-yield.4

Uncertainty Drives Yields Further Down

As the world’s economy continues to show signs of sluggishness, with global growth slowing down, low inflation and interest rates that continue to spiral downwards, investors are turning to bonds as a safe place to park their cash.5 As governments issue their debt with ever lower interest rates, investors (and even businesses with excess cash) are seeking to buy up existing government bonds, issued in years past, which were issued with higher interest rates. These bonds with higher interest rates command higher prices on the secondary market, as holding these bonds means that the benefactor will receive higher coupon (interest) payments. As the price of these bonds increase, their yield decreases. The buyer pays more money to buy the bond, bearing the higher interest rate, but as the price paid climbs higher, the value of those interest payments to be received remains the same, so that the bond “yields” a lower value in relation to the price paid for it.

Many investors and businesses purchase international bonds from foreign countries. To do so, however, they often must utilize international wire transfers, or foreign currency exchange services. These service providers can help businesses transfer funds internationally, as well as conduct foreign exchange of their currencies, so that the businesses can purchase international bonds in foreign markets.

Uncharted Territory for Bonds

While bond yields have historically fluctuated, trending both upwards and downwards, investors in the market are seeing something unusual: negative yielding bonds. Currently, there is some US$12 trillion in outstanding bonds whose yields have dipped into negative territory.6 This means that prices for some bonds have climbed so high, buyers of those bonds are actually paying a premium to be able to purchase higher interest bonds – even at the risk of paying a high sum for the bond than the principal value or interest payments could ever reach. For example: a bond with a principal amount of US$1,000 (at the maturity date of the bond, the bond holder will receive a payment of US$1,000) and remaining interest payments worth US$250 would normally have a trading price in the secondary market of slightly below US$1,250. The lower price takes into account the decreased value of money in the future due to inflation, as well as the slight risk of the bond issuer defaulting, etc. But today, that bond may actually be sold for over US$1,250, even though its principal and interest would never amount to more than US$1,250. Thus, its yield would be said to be negative.

The Takeaway

As new bonds are issued with lower and lower interest rates, investors continue to seek to invest their cash in the security of government bonds. In a time of increasing uncertainty in a global economy and countries’ interest rates, some investors see bonds that promise a reliable stream of interest payments as an attractive option.

Phillip Silitschanu

The Author

Phillip Silitschanu

Phillip Silitschanu is the founder of Lightship Strategies Consulting LLC, and CustomWhitePapers.com. Phillip has nearly 20 years as a thought leader and strategy consultant in global capital markets and financial services, and has authored numerous market analysis reports, as well as co-authoring Multi-Manager Funds: Long Only Strategies. He has also been quoted in the US Financial Times, The Wall Street Journal, Barron's, BusinessWeek, CNBC, and numerous other publications. Phillip holds a B.S. in finance from Boston University, a J.D. in law from Stetson University College of Law, and an M.B.A. from Babson College.

Sources

1. U.S. Government Bond Yields Hover Near Historic Lows, The Wall Street Journal, http://www.wsj.com/articles/u-s-government-bond-yields-hover-near-historic-lows-1467815469.
2. U.S. Government Bond Yields Hover Near Historic Lows.
3. Japan’s Negative-Rate Experiment Is Floundering, The Wall Street Journal, http://www.wsj.com/articles/japans-negative-rate-experiment-is-floundering-1460644639.
4. U.S. Government Bond Yields Hover Near Historic Lows, The Wall Street Journal, http://www.wsj.com/articles/u-s-government-bond-yields-hover-near-historic-lows-1467815469.
5. U.S. Government Bonds Take a Breather After Brexit Rally, The Wall Street Journal, http://www.wsj.com/articles/u-s-government-bonds-take-a-breather-after-rallying-on-brexit-1467123864.
6. Need for yield sends bond and equity prices in lockstep to record, Financial Times, https://next.ft.com/content/5ea2d076-4733-11e6-8d68-72e9211e86ab.

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