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Explained: Why China’s negative yield bonds are in demand

At a time when the world is battling the Covid-19 pandemic and interest rates in developed markets across Europe are much lower, investors are looking for relatively better-yielding debt instruments to safeguard their interests.

Written by Sandeep Singh , Sunny Verma | New Delhi |
Updated: November 24, 2020 7:54:51 am
People with face masks gather near a giant TV screen broadcasting news of Chinese President Xi Jinping, at a shopping mall in Beijing, Sunday, Nov. 22, 2020. (AP Photo: Andy Wong, File)

Last week, China sold negative-yield debt for the first time, and this saw a high demand from investors across Europe. As yields in Europe are even lower, there was a huge demand for the 4-billion-euro bonds issued by China. China’s 5-year bond was priced with a yield of –0.152%, and the 10-year and 15-year securities with positive yields of 0.318% and 0.664%.

What are negative-yield bonds?

These are debt instruments that offer to pay the investor a maturity amount lower than the purchase price of the bond. These are generally issued by central banks or governments, and investors pay interest to the borrower to keep their money with them.

Why do investors buy them?

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Negative-yield bonds attract investments during times of stress and uncertainty as investors look to protect their capital from significant erosion. At a time when the world is battling the Covid-19 pandemic and interest rates in developed markets across Europe are much lower, investors are looking for relatively better-yielding debt instruments to safeguard their interests.

Why is there a huge demand?

The fact that the 10-year and 15-year bonds are offering positive returns is a big attraction at a time when interest rates in Europe have dropped significantly. As against minus —0.15% yield on the 5-year bond issued by China, the yields offered in safe European bonds are much lower, between –0.5% and —0.75%.

Also, it is important to note that while the majority of the large economies are facing a contraction in their GDP for 2020-21, China is one country that is set to witness positive growth in these challenging times: its GDP expanded by 4.9% in the third quarter of 2020.

While Europe, the US and other parts of the world are facing a second wave of Covid-19 cases, China has demonstrated that it has controlled the spread of the pandemic and is therefore seen as a more stable region. Many feel that European investors are also looking to increase their exposure in China, and hence there is a huge demand for these bonds.

What is the key factor driving this demand?

It is the massive amount of liquidity injected by the global central banks after the pandemic began that has driven up prices of various assets including equities, debt and commodities. Banking industry sources said many investors could also be temporarily parking money in negative-yielding government debt for the purpose of hedging their risk portfolio in equities. In case the fresh wave of the Covid-19 pandemic leads to further lockdowns of economies, then there could be further negative pressure on interest rates, pushing yields down further, and leading to profits even for investors who put in money at the current juncture. Global central banks have injected an estimated more than $10 trillion of liquidity through various instruments in the financial system — which is finding its way into various assets in the economy.

“There is an expectation that the new US government may impose fresh lockdowns in the economy as Covid cases are picking up in various US states and European countries, whereas China seems relatively safe now from that perspective. This is expected to lead to volatility in the financial markets in coming days, pushing up demand for safety of capital alongside flows into risk assets,” a senior financial sector analysts said. He said institutional investors would look at the overall returns after factoring in the sharp gains from equities and commodities and discounting the negative returns on capital being used for the purpose of hedging. 📣 Express Explained is now on Telegram

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