Is nothing sacred in today’s topsy-turvy world?

In a stunning development presaging the insanity of a deflationary environment in a capitalist economy, chocolate maker Nestle issued bonds today that pay a negative yield. That’s right, “investors” were lining up to pay Nestle 0.0081% interest for the privilege of loaning the firm money (buying October 2016 bonds).

Deflationary logic leads to negative yield on Nestle bonds

This apparent insanity makes a little more sense if you consider the Nestle bonds are denominated in the euro. Consumer prices are decreasing at an annual rate of 0.6% in the eurozone currently, so a euro is likely to be  worth more tomorrow than today. That’s means the euros you’ll get paid back with will be worth more than the euros you’re paying out right now.

The twisted deflationary logic is you can lose money, but still make money relative to leaving it in the bank (at similar negative interest rates) given that there is small “collateral premium on bonds”.

Nestle

All about “protecting cash”

Thibault Colle of UBS commented in an interview with the Financial Times that most investors in blue chip corporate bonds were more worried about protecting their cash than chasing yield given the poor economic situation in Europe.

“We’re not in an economic cycle where you start to see growth coming through so investors focus on preserving their capital,” he noted. “The ECB is in easing mode and that’s a great place for fixed income rather than equities because the growth story for earnings simply isn’t there.”

QE is a dream come true for bond issuers such as companies and governments, as their borrowing costs have dropped to all-time lows.

Furthermore, huge amounts of government debt have turned to negative yields since the ECB became the first central bank to begin charging banks to hold their surplus cash last June. Over €1.5 trillion of euro area debt maturing in longer than a year now has a negative yield, according to JPMorgan.

German and Danish debt now has negative yields on bonds with maturities as long as six years. The Netherlands, Sweden and Austria all have negative yields on bonds up to five years while Swiss bonds are now negative in maturities up to a stunning 13 years.

These historically low yields have encouraged governments to issue longer-term debt to lock in low rates. Ireland, Portugal and Italy all recently sold 30-year bonds, with almost-bankrupt-just-a-few-years-ago Ireland able to borrow at just over 2% annually.

Salman Ahmed of Lombard Odier Investment Managers noted the ECB’s larger than expected QE programme could create severe dislocations in fixed income markets. “Unlike the US and UK, the ECB’s programme will eat into the existing stock of debt securities held by banks and investors rather than just offsetting the new flow of securities,” he said. “It is highly conceivable in our view that highly rated European sovereign credit will remain in negative yielding territory for the foreseeable future.”