Treasury bonds issued by the U.S. government on Monday broke new ground by carrying a negative yield for the first time.
Institutional investors snapped up $10-billion (U.S.) worth of five-year bonds at auction, even though the nominal return was less than zero - a yield of negative 55.5 basis points. There have been previous sales of bonds with negative yields, but only in the secondary market.
Although this stems from record low interest rates and expectations that the Federal Reserve will soon launch a new round of quantitative easing, it does not signal that investors have suddenly decided they would prefer to pay for the privilege of holding U.S. debt than put their money in riskier assets.
Rather, it is a reopened issue of debt that originally came to the market in April. The bonds are TIPS - Treasury inflation-protected securities.
"It was a surprise that the auction came through the market, especially considering it is the first TIPS issue to come with a negative yield," John Briggs of RBS Securities said in a note to clients.
But it underscores growing investor interest in inflation-protected assets in advance of the Fed's expected move to buy as much as a trillion dollars worth of bonds to reflate the struggling economy.
If this had been a new bond issue, with the price back at par, the yield would have been in positive territory. The expected return at maturity is still expected to be positive - so long as annual inflation creeps above 1.56 per cent, which would be the break-even point on the bonds.
"On the surface, it looks negative, it looks deflationary," said David Ader, head of government bond strategy with CRT Capital Group in Stamford, Conn. "In fact, it's really a function of the price, because it's a reopened issue."
Investors are willing to accept a negative nominal yield because these are bets on inflation. The current real yield on regular five-year Treasuries runs 1.18 per cent, nearly 40 points below the inflation rate. "So TIPS, by definition, are going to be a negative 40 basis points in a break-even scenario," Mr. Ader said.
Buying anything in the bond market today carries added risk because yields are so low. "However, if you're willing to buy a five-year Treasury at less than the inflation rate, buying a TIP at negative yield [makes more sense]" Mr. Ader said, because the underlying value of the bond rises with inflation.Report Typo/Error