Bond investors in Europe and Japan are losing money to save it

▶ Investors in Europe and Japan are paying up for safety ▶ “At the moment there seem to be few alternatives”

It’s not as if Christoph Kind relishes putting his clients’ money into bonds that pay nothing in interest and can all but guarantee losses. But Kind, the head of allocation at Frankfurt-Trust Asset Management in Germany, is doing just that. And he’s hardly the only one.

In Europe and Japan, central banks have set some rates below zero— an idea that’s hard to get one’s head around. But negative yields for bond investors have already become an everyday reality.

Yields fall when bond prices rise. They go negative when the price is higher than all future interest and principal payments. In Germany, surging demand for two-year government debt has pushed yields to -0.53 percent per year, meaning an investment of €10,000 would pay back only €9,894. The average yield on all €1.1 trillion ($1.2 trillion) in German bonds was sub-zero every day for more than two weeks as of Feb. 23. That’s the longest stretch of money-losing rates ever, according to Bank of America. In Japan, bond prices are so high that almost two-thirds of government debt, amounting to $4.5 trillion, has a negative yield, according to data compiled by Bloomberg.

Behind the low rates are fear and growing skepticism that central banks’ dramatic rate cuts will be enough to reignite the global economy. Worries over the economic health of China and the U.S., plus volatility in stocks and oil prices, have many investors looking for safe assets. Even with slightly negative yields, the bonds issued by Germany and Japan at least offer liquidity and the assurance that they won’t default.

“Risk-free now has a cost,” and clients are learning that they should accept it, says Mauro Vittorangeli, a senior fixed-income money manager at Allianz Global Investors, which oversees about $505 billion in assets.

The low rates also suggest markets see little risk of a spike in inflation, which would make holding negative-yielding bonds even more painful— and likely prompt central banks to raise rates and thus make existing bonds less valuable. (Even government bonds that won’t default can lose market value before they mature if rates rise.) A majority of economists in a Bloomberg survey say negative rates will be in place at the European Central Bank at least until the first

quarter of 2018, and at

the Bank of Japan even longer.

“This is quite a tricky situation,” says Frankfurt-Trust’s Kind. He worries that with bond prices so high, investors are vulnerable to a selloff if the consensus on future rates and inflation proves wrong. Still, Kind has bought negative-yielding bonds in recent weeks. “It’s tough at these levels, but at the moment there seem to be few alternatives,” he says.

Consider the case of U.S. Treasuries. David Ric, head of absolute-return fixed-income strategies at the asset manager Amundi, calls them “the least ugly duck out there.” Federal Reserve Chair Janet Yellen bucked the trend among central banks by raising short-term rates in December by 0.25 percentage points from nearzero. Even so, 10-year U.S. debt yields only 1.7 percent, down about half a percentage point since the start of the year. That’s much better than the 0.14 percent investors are getting for 10-year German bonds—until currency exchange is factored in. Treasuries gained about 1.1 percent in February, but Europeans holding them lost 0.77 percent in euros as the value of the dollar fell. It’s possible to use hedging contracts to eliminate such currency risk, but the cost of doing so results in a return that’s no better for Europeans than buying German bonds.

Japanese investors face a similar lack of options. Factoring in assumptions about future interest rates and foreign exchange, a Bloomberg analysis shows that 10-year U.S. Treasuries are likely to yield -0.7 percent in yen. For now, that leaves European and Japanese investors facing the prospect of losing money in order to save it. Says Allianz’s Vittorangeli: “We are in a totally new world.”