If investors in the U.S. want a lesson on negative rate government bonds they need to look no further than Germany over the past three months.
Germany’s two-year note – the “Schatz” – dipped its toe into negative yield territory at the beginning of June. Downward pressure eased through the rest of the month and bond yields closed positive each day.
It was just temporary relief as yields fell again in July – consistently closing negative and reaching an all-time low of -0.12 on July 27, as you can see here…
U.S. Treasuries could easily see the same plunge below zero as investors become more willing to pay for the return of capital. The next flare up of fear is all that’s needed to make institutional money willing to park capital at negative yields.
But that’s not the whole story…
There is one factor that may be putting pressure on German bonds… something that won’t be a factor at all for U.S. Treasuries. That is, German bond buyers may be betting on the euro falling apart.
The theory goes like this: German bonds are currently payable in euros, but would (presumptively, when the euro dissolves) be payable in the post-euro Deutschmark, which would be a considerably stronger currency than the current euro.
This currency conversion would give a meaningful boost to the returns of German bond buyers… ultimately making their acceptance of negative yields not only a safe play, but also a profitable bet against the euro.
Speaking of the euro… here’s a chart of the currency over the last three months. You can see it correlates quite well with German 2-year yields.
Whether the driving force behind negative German bond yields is a flight to safety or a bet on a future Deutschmark, it’s likely we’ll see super low rates for some time.
If you haven’t done so already read the Survive & Prosper issue on “Treasury Sells Floating Rate Notes”.