The “Mass Psychosis” in Bonds Takes a New Twist

A propitious day in our era of negative-yield pandemic.

For the first time ever, Germany sold 10-year bonds with a zero-percent coupon today. It sold these “Bunds” at a price that was above face value. So not only do investors not get a coupon payment, however minuscule, they’re also not getting all their capital back when the bonds are redeemed in 10 years at face value.

So on this propitious day in our era of negative-yield pandemic, these Bunds in the €4.038 billion issuance produced a negative yield of -0.05% and no coupon payments.

The only way buyers can make money on these things is if the yield drops deeper into the negative, and if they sell the bonds at this lower yield and thus at a higher price well before the maturity date – because on the maturity date, these bonds are worth their face value, not a cent more, no matter what the interest rate may be.

Buyers that hang on to these bonds until maturity, which is what many buyers have to do to meet their needs – such as pension funds, insurance companies, etc. – are guaranteed a capital loss plus zero interest income, topped off by the loss of purchasing power due to 10 years’ worth of inflation.

If rates rise, traders will lose a ton of money, and those holding the bonds to maturity will also lose money. So this is a royal rip-off.

But no problem. In the secondary markets, 10-year Bunds trade today with a yield of negative -0.14%.

These 10-year Bunds are used as a benchmark for pricing other European securities. Hence, the guaranteed losses will reverberate through the investment environment.

By now, the ever growing global pile of bonds with negative yields has reached about $13 trillion.

Why would anyone be this stupid? Why would so many investors be so stupid? Why would the biggest buyers of this rip-off – institutional investors who manage other people’s money – be so stupid? No one knows. “Central banks made us do it,” they’ll say afterwards as an excuse.

Bond specialist Jeffrey Gundlach, CEO of DoubleLine Capital, has another phrase to describe the phenomenon: “Mass psychosis”:

“There’s something of a mass psychosis going on related to the so-called starvation for yield,” he said during a webcast yesterday, according to Bloomberg. “Call me old-fashioned, but I don’t like investments where if you’re right you don’t make any money.”

In theory, at least, rates can rebound. But Gundlach doesn’t expect that to happen quickly. He said it might take till next year before the 10-year Treasury yield will once again exceed 2%. It’s now at 1.46%.

Gundlach offered another gem, this one about a potential bank bailout to deal with the European banking crisis, according to Bloomberg:

Policy responses to insolvency concerns for European banks are likely to be “bond unfriendly,” creating inflation “that would take everybody by surprise.”

A bout of inflation would be the killer app. It would destroy those bondholders that are not being compensated for any risks, including inflation, and who, as is the case in Europe and Japan, are paying for the privilege of lending to the government. If inflation ranges around the 2% that central banks are talking about, the 10-year Bunds with their zero coupon and their negative yield will lose nearly 20% in purchasing power when they’re redeemed. But inflation could go quite a bit higher….

And why do institutional investors stand in line to buy these bonds? Mass psychosis, as Grundlach said, is one reason. The other may be that they don’t have a choice (and central banks know that); and that ultimately they’re managing other people’s money, and so who cares?

Ironically, the Fed, which kicked off this madness in grand style during the Financial Crisis, is currently the only one of the big central banks flip-flopping about raising rates. The Bank of Japan, which invented this madness years before the Financial Crisis, the ECB, which belatedly got into this madness, and other central banks are flip-flopping about lowering rates and diving deeper into their QE shenanigans.

Here’s the gloomy scenario the “smart money” is betting on. Read…  Fear, Loathing & Record Money-Making in Government Bonds

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Wolf Richter

In his cynical, tongue-in-cheek manner, he muses on WOLF STREET about economic, business, and financial issues, Wall Street shenanigans, complex entanglements, and other things, debacles, and opportunities that catch his eye in the US, Europe, Japan, and occasionally China. WOLF STREET is the successor to his first platform… TP-Title-7-small-200px …whose ghastly name he finally abandoned in July 2014. Here’s the story on that. Wolf lives in San Francisco. He has over twenty years of C-level operations experience, including turnarounds and a VC-funded startup. He earned his BA and MBA in Texas and his MA in Oklahoma, worked in both states for years, including a decade as General Manager and COO of a large Ford dealership and its subsidiaries. But one day, he quit and went to France for seven weeks to open himself up to new possibilities, which degenerated into a life-altering three-year journey across 100 countries on all continents, much of it overland. And it almost swallowed him up.