Germany and Switzerland have many differences despite their proximity to each other. Future financial historians will likely note 14 June 2016 as the day when there was one difference less: Namely, the yield on Germany’s 10-year government bond went negative.
Owing in part to rising uncertainty over whether the U.K. will vote later this month to leave or remain in the European Union, to the European Central Bank’s negative interest rate policy and buying €80 billion worth of bonds each month, and to secular forces driving the investment rate lower and the savings rate higher, Bunds intermittently dipped below the zero line to ‒3 basis points. While that’s new for Germany, it’s old news for Switzerland. Ten-year Swiss government bonds have been below zero since early 2015 and now yield (can one even say that about negative rates?) an eye-watering ‒0.5%. So the Swiss bond market at least has already charted this territory.
While negative rates might be described as “unnatural,” financial history suggests they could persist for some time. As John Maynard Keynes – a brilliant economist who was wiped out as a speculator – once said, “The market can stay irrational longer than you can stay solvent.” And history reminds us the Japanese government bond market earned the name “widow-maker” in the 1990s for the ability of its bond prices to defy gravity.
Negative-yielding bonds are certainly no table-pounding investment, but we are not in a rush to call an end to this phenomenal bull market in global government bonds just yet. In fact, we are pleasantly surprised that trades such as the synthetic cash-futures basis, which exploits the difference between actual and implied repo rates on bonds, continue to be attractive in this low-yield environment. That’s just one example of what PIMCO calls “structural alpha” trades, which take advantage of premiums in the bond market to potentially increase returns. To put it simply, in our opinion, there’s never been a better time for active bond management.