An expert opinion on negative-yield government bonds: Just nuts
Much of the financial world and the business news media spent last Wednesday morning obsessing about whether the Federal Reserve would announce a cut in short-term interest rates later in the day.
But I decided to do something different. Rather than play the “What will the Fed say this afternoon?” game, I spent the morning having breakfast with one of Wall Street’s gods, Joe Rosenberg. And after our meal, I decided it made more sense — and would be more useful to you — for me to channel Rosenberg than for me to write about the Fed. So that’s what I’m doing.
Rosenberg is an outspoken world-class bond maven who recently retired from Loews Corp. after 45 years of helping the company manage its investments. He’s been involved with Wall Street since 1961 and is still going strong.
These days, he spends his time managing his family’s money and consulting for a handful of clients. He and I have been friends for decades, despite the fact — or maybe because of the fact — that we disagree more often than we agree.
I wanted Rosenberg to help me understand why about half the securities issued by European governments have negative interest rates.
I also wanted to know whether the existence of that $12 trillion — that’s trillion, with a “t” — of negative-yielding foreign government bonds helps explain why yields on U.S. Treasury securities have fallen substantially this year without the Fed cutting rates.
And, as a bonus, Rosenberg told me why if the Fed cuts short-term rates at its meeting, it could raise — not lower — interest rates for new mortgages.
Neg-yield bonds first. Rather than invent a rationale to explain the unexplainable — as many Wall Street types have been known to do — Rosenberg thinks that it’s nuts for investors to lock in guaranteed losses by buying negative-yielding government bonds issued by the likes of Switzerland, Sweden, Germany, France, the Netherlands and Japan.
Anyone buying those bonds at current prices is paying more for them than the total interest and principal that the bonds will pay between now and when they come due. Holders, in effect, are paying for the right to own a government IOU. They’d get a better return — zero — by stashing cash under a mattress.
Rosenberg attributes what’s happening to market forces and momentum, not rational analysis. Even though he and people like him are warning that buying negative-yield bonds is crazy (to use the technical term), prices of these bonds are getting higher and higher, making the yields more and more negative.
“Anyone who’s bought them is way ahead,” Rosenberg said. “People are buying into the bond bubble because they’re watching other people making money” on rising bond prices.
The problem, of course, is that one day the bubble will pop. And people now sitting on profits will have serious losses when yields on these securities turn positive. Which seems inevitable, no matter what the European Central Bank tries to do.
Now, to the U.S. market. Given that trillions of dollars of European government bonds and some Japanese bonds are in Neg-Yield Land, Rosenberg says, it’s natural that money that would normally be invested in those securities has flooded into U.S. Treasury securities.
Even though Treasurys’ yields are very low by historical standards — they range from about 1.8 percent to 2.5 percent — at least they’re positive. A 10-year Treasury yielding 2 percent is no prize, but it beats a 10-year German bond yielding minus 0.6 percent or a 10-year Swissie at minus 0.8.
The influx of money from yield-starved foreign-bond investors helps explain why Treasury rates have been going down this year despite huge and growing federal budget deficits that require the Treasury to borrow more and more money to fill the gap.
Yields on a key security — the 10-year Treasury note — are down more than half a percent since the start of the year. The 10-year is important because it has a huge influence on the rates that lenders charge for new long-term mortgages.
Rosenberg says that if the Fed cuts short-term rates at its next meeting, it could raise the yield on 10-year notes because investors will begin to worry more about inflation eroding the value of their principal. And if rates on the 10-year Treasury go up, rates on new mortgages will rise, too.
Rosenberg has made his career as a risk-taking contrarian. In the early 1980s, when Treasurys were yielding 15 percent because most investors shunned them, he had Loews buy them, and make a ton of money as rates fell.
During the Internet stock bubble in 2000, many people said it was a new world with new rules. Rosenberg — the kind of guy who brings the 663-page third edition of Sidney Homer’s “A History of Interest Rates” to breakfast at a suburban diner — said it was the same old world and most of those stocks would crash. Which they did.
Rosenberg, who has told me over and over that central banks frequently follow markets rather than lead them, isn’t sure where things go from here. (Who is?)
One thing he is sure of, though, is that “something that we can’t predict” will pop the negative-yield bond bubble. And that the fallout will be ugly because “things go down much more quickly than they went up.”
So when that bubble pops, remember that Rosenberg warned you about it before it happened.