Bond market
While 2014 proved to be a fruitful year for the yields in the bond market as witnessed by the high positive yields, the same could not be said of 2015. Numerous factors came to play at the start of 2015 that ensured the bond market changed significantly (Perović, 2015.) The first significant factor was the performance of the economy. Stagnant economic growth and persistent fears of deflation occurring in an economy are the primary reasons that persuade monetary authorities to cut the rates of interest. In 2015, the cutting of prices with deposit rates set below zero and a combination of other measures by the government, including actions such as quantitative easing that saw the government purchase securities from commercial banks through operations such as open market operations, increased the circulation of money in the economy. The increased money supply also aimed at reversing the general trend of slowed economic growths, and while the economy was still affected by the effects of the actions taken, it resulted in a situation where the yields on bonds to fall below zero. In 2015, the presence of increased regulations also meant that many institutional investors, such as insurance and pension funds, had no option but to invest markets of bonds to maintain the prescribed liquidity ratios (Ebeke and Lu, 2015). The capital regulations thus played a significant role in ensuring that the demand for the low yield and even negative yield bonds increased as investors did not want to be on the wrong side of the law.
The low yield bonds only prevail on an economy that is characterized by slow activities and the need for the government to stimulate the economy. With monetary policy tools available at the disposal of a government to use as a remedy for a prevailing economic situation, it is safe to say that the low yield bonds only occur for a specified period. Again, many bods, especially those that are issued by the governments, tend to attract many investors, given the fact that they are instruments that have low risks. It is quite possible for the situation to turnaround within the shortest period. While the slowed level of economic growth forces government to increase the supply of money in the economy as was the case in 2015 with the hope that increased supply of money will stimulate economic growth, monetary policies also allow for the government to wipe out the excess amounts of money in an economy when growth resumes (Buttonwood, 2015). Hence, when the economy manages to come out of the deflation that characterized the low yield bonds and the risk appetite of the investors as well as the availability of other bonds with positive returns start to happen, investors will shift back. The negative yield bonds will no longer exist.
The yield of a bond and its price have a negative relationship simply because as the price of a bond increases, the yield on the same bond will decrease. If the interest rates of a bond increase, the price of the bond falls and all this has to do with the effects of the time value of money and the discounting of the bond prices. A fall in the interest rates makes the price of the bond to rise as investors see the payment from the bond in the form of coupon payments at the stated time as attractive. Understanding the current yield and being able to get a rough estimate of the bond yield thus determine the price of the bond and that was evident in the year 2014 and 2015. At first, the high yield in the bonds in the year 2014 made the bonds attractive to the investors and as such, the price was somehow down. With many investors purchasing the bonds in the year 2015, the yields went down a resulting in an almost negative yield bond (Gruber & Kamin, 2012). A speculative investor would thus prefer to hold such bonds rather than selling immediately and making losses as holding the bonds as the ability to impact on the future payments that they would derive from the bond.
Several reasons explain the action of investors to purchase negative yield bonds in 2015. Ideally, investors should look for bonds that offer positive interest and the fact that they opted for those bonds yielding negative interests was driven by a combination of different factors. The first was risk-averse investors who were willing to accept the negative yields as a premium. For them, the fact that their money was in a security instrument and liquid debt was better than having the money deposited in banks that would also face the consequences of such slowed growth in an economy (Oliver, 2019). Another reason for holding a negative yield bond is for speculative purposes where an investor believes that the bond currency in which the bods are denominated will rise and by so doing, affect the price. Holding a negative yield bond is also advantageous for capital gains. The price of the bonds and the interest rates move in different directions and if the negative yield bond falls even further, then it will be possible for the investor to make sort of capital gain. The demand for the negative yield bonds could also be driven by the pension and insurance companies that are legally required to purchase certain types of securities and include such securities in their asset portfolio regardless of whether the securities have a positive or negative yield.
The trends in the bond market have, over the years, indicated many trends, and the data presented shows that the return in the form of the yield of the bonds is sensitive to the prevailing market conditions and changes.
Bibliography
Buttonwood, 2015. Accentuate the negative: Why investors would opt to lose money. The Economist January 24, 2015.
Ebeke, C. and Lu, Y., 2015. Emerging market local currency bond yields and foreign holdings–A fortune or misfortune?. Journal of International Money and Finance, 59, pp.203-219.
Gruber, J.W. and Kamin, S.B., 2012. Fiscal positions and government bond yields in OECD countries. Journal of Money, Credit and Banking, 44(8), pp.1563-1587.
Perović, L.M., 2015. The impact of fiscal positions on government bond yields in CEE countries. Economic Systems, 39(2), pp.301-316.
Oliver, S (2019). Global growth slowing, plunging bond yields & inverted yield curves – not terminal, but shares are due to a pullback. AMP Capital, March 26, 2019.