How is fiscal policy affected by negative yielding bonds?

This morning has started with a familiar drumbeat for these times. The ten-year yield in Germany has fallen to a mere 0.022% so not only is it being paid if it issues bonds up to nine years in maturity the benchmark ten-year is on the edge of joining it.Also it is a sign o’ the times that it is now being measured in hundredths. If we move across the border to Switzerland then this happened on Wednesday. From the Financial Times.

The Swiss National Bank has announced it will be selling 13-year bonds, maturing in June 2029, with a zero per cent coupon, its lowest fixed interest rate on record…….It seems likely that investors will be prepared to buy the debt for a guaranteed loss.

Actually as a technical issue let me correct the FT as you only have a “guaranteed loss” if you hold to maturity. In the frenzied world right now you may get a short-term profit. Even if you go out some 30 years then you are struggling to get even a 0.1% yield. I note that the average yield on both German bunds and Swiss bonds is negative which means as a broad brush they are being paid to borrow overall.

Not everybody is in that boat but the ten-year UK Gilt yield dropped to a record low 1.22% and the US Treasury Note ( ten-year) has fallen to 1.67%. So as the FT tells us.

Super low and sub-zero yields, once a source of shock, are becoming a standard part of Europe’s bond markets

I am not sure why they specified Europe as the US yields are historically very low and of course the land of the rising sun or Nihon has a ten-year yield of -0.14%. Oh and speaking of Japan.

Japan PM Advisor Nakahara: Suggests Boosting JGB Purchases To JPY100 Tln Per Year -Should Increase Easing As Soon As Next Week (@livesquawk ).

Or monetary policy meet fiscal policy or if you prefer vice versa.

What about fiscal policy?

The current situation poses some new questions for fiscal policy. There have been people in favour of a fiscal boost all along or to be more accurate more of a fiscal boost as the vast majority of countries run annual deficits. But in a nutshell the past thinking was on the lines of an expansionary policy would lead to high bond yields and possibly much higher ones should it look to be getting too high. The too high was always a bit vague with no specific levels of deficit or national debt. However A threshold did exist in the past for the UK amongst others and we saw for a while the “Bond Vigilantes” sending bond yields in the countries affected by the Euro crisis much higher. It seems extraordinary now to point out that Portugal’s benchmark bonds had a yield in the mid-teens as opposed to the 3% or so that the mainstream media tells us is a crisis now.

There are several issues to this. Let me start with simple bond management where there are two impacts. The most obvious is that it is either cheap to issue or you are paid to do it. The second is a quantity one which is you will be able to sell a lot of bonds to a yield hungry world if you nudge your yields a little higher as the Bond Vigilantes turn into Pac-Men and women. Only countries perceived to be a pretty extreme crisis will be exempt from this.

A Fiscal Boost

This has become extremely fashionable and links back to my article of yesterday when I looked at a speech made by ECB President Mario Draghi.

This is why the ECB has said many times that fiscal policy should work with not against monetary policy, and the aggregate fiscal stance in the euro area is now slightly expansionary.

He is hinting at a welcome for a more expansionary policy which gets a lot clearer if you read between the lines here.

But the orientation of other policies also influences the speed with which output returns to potential. So if other policies are not aligned with monetary policy, inflation risks returning to our objective at a slower pace.

As Mario is stamping the pedal to the metal with his monetary policy he is plainly pushing for an easier fiscal stance which is of course the opposite of past ECB advice. So many central bankers seem to take the words of Margaret Thatcher “U-Turn if you want to” as a strategic plan these days don’t they?

Japan is also switching one of the tenets of Abenomics. You see the initial fiscal and monetary boost was supposed to provide such growth that everything would be better except as the FT reported at the beginning of the month.

Japan’s fiscal situation is the worst among the major industrialised economies.Its government debt exceeds 200 per cent of gross domestic product — worse than Greece.

In fact in the Abenomics fantasy world reality appears to have disappeared.

Mr Abe said during a press conference on Wednesday that he would not change a target of achieving primary balance surplus in fiscal year 2020, but how he can meet this goal is now unclear.

So a fiscal consolidation becomes a fiscal boost but don’t worry as the future is bright! Sadly like in the UK the fiscal future that is bright is 3/4 years away whenever you start from.

Germany Japan and Switzerland

These three countries could undertake a fiscal boost right now and be paid to do so. They would be better off in annual terms by doing so. Firstly let me give you some musical accompaniment to this idea from OMC.

How bizarre
How bizarre, how bizarre

There are even a couple of lines from the song for the Bond Vigilantes.

It’s making me crazy
(It’s making me crazy)

So Germany could borrow and boost the Euro area in a way that those who argue against imbalances would consider as Christmas come early. Switzerland could do the same and again boost the Euro area. Japan could join in or to be more specific it could add to its existing fiscal boost and hope that doubling-down again would work and likely be paid to do it.

GDP Linked Bonds

Jens Weidman of the German Bundesbank has highlighted this today.

zero-risk weighting of sovereign debt distorts capital allocation and therefore acts as a drag on growth…..Doing away with sovereign debt as a cluster risk would also pave the way for the orderly restructuring of sovereign debt

At first sight he is saying how silly the current situation is although avoiding the fact that the ECB of which he is (mostly) a voting member has driven it both theoretically and practically. So the suggestion is as follows.

A recent initiative by the Bank of England is pushing for the introduction of standardised GDP-linked bonds. By tying coupon payments, and potentially the principal as well, to a country’s growth rate, investors share both the upside and the downside risk of a country’s economic development.

You may recall this was suggested for Greece back in the day and investors can let out a sigh of relief it never happened as the ongoing economic depression would have made their investments take an ice bath. For Germany right now it would not far off define insanity but there are problems. The Bank Underground blog unwittingly helps us out.


What could go wrong?

Let me throw in another problem which is changes to GDP itself. In the last few years the UK has made several by changing its inflation definition ( worth around 0.5% per annum of “extra” growth) and the ESA 10 changes such as drugs and hookers as well as double counting Research & Development which was worth around 4%. A nice windfall for those in the know?


Negative yielding bonds provide quite a windfall for fiscal policy. There is a flow one which the media mostly ignores but there is the opportunity for a capital one should the 3 main beneficiaries use it. It is not quite a “free lunch” although it would be for a while a lunch that you were paid to eat. What I mean by that is that the national debts would rise and also the bonds would as a minimum have to be refinanced in the future and maybe in some sort of alternative universe – the sort of place where Spock in Star Trek has emotions – be actually repaid.

So thoughts?


21 thoughts on “How is fiscal policy affected by negative yielding bonds?

  1. The whole thing seems to a simple person like me to be best summed up by Walter Scott with his line “Oh, what a tangled web we weave / When first we practise to deceive”.
    Printing money seems to me to have divorced the whole system from reality. The central banks will do “whatever it takes” to use unlimited printing capacity to buy up government bonds, which reduces the interest cost to governments of borrowing, which leads to greater freedom to spend money in the real world. They then turn to corporate bonds, with the same effect. This is pure market rigging IMHO and, I believe, this can only end up badly. When and how I cannot predict, but I just don’t see how it can end well.

    • Hi James

      We find ourselves returning to the question of why more and more of the “medicine” is needed? After all cures have a set time not ever larger doses. That is a sign of something which is not working or is more of a palliative.

      Now the central bankers find themselves as big fish in relatively small ponds. For example the Bank of Japan its role as the Tokyo Whale in equity ETFs or now the ECB buying Corporate Bonds faster than they are being issued. To what end and as I often ask with what exit strategy?

  2. Hi Shaun
    A really exceptional blog today.
    I liked the comment of Bill Gross that negative
    interest rate government bonds is a supernova
    that will explode one day. When?
    On a personal note I cashed in my
    pp’s 3 and 5 years early, not because I enjoyed
    a haircut, but because I thought that a smaller
    amount was better than the potential for it to be
    bugger all!
    Maybe one day far far into the near
    future there may be a helicopter drop of money
    and bonds, it’s life Jim, but not as we now it.


  3. Another top class piece of work Shaun, and it always returns my mind to one (I think crucial) question, and it is this:
    We know that CBs are purchasing govt. bonds at negative yields; we know that certain financial institutions have to purchase govt. bonds as low risk assets, BUT…What is the huge level of risk everywhere that allows govts to sell bonds at zero or negative interest rates on the open market, because it seems to me that fear of this risk must be so great as to be both ubiquitous & untouchable, and investors are steering clear, or no bonds whatsoever are being sold on the open market other than those mentioned?

    • Hi therrawbuzzin

      We see fear as you point out in the bond markets but also greed in equity markets with the Dow Jones so recently being above 18k. Both of course have been aided and abetted by central banking policy.

      Those who invest for yield and some have to ( pension funds, annuities etc..) have fewer and fewer places to go and even there they get less. Do you have the feeling that “innovation” will come a cropper again?

      Foreign purchases can provide something of a rationale. People were curious why the Chinese were buying negative yielding Japanese bonds until I pointed out that it was in essence a Yuan/Yen currency play. Of there was was also the purchases of Euro area bonds by the Swiss National Bank. But of course we are back to central banks again….

      Goodhart’s Law could not be more clearly in play I think.

  4. When previous economic crashes have occurred there has been little warning for the ordinary person and after a period normal service resumed.
    This time despite all the talk (lies /delusional thinking) there has been no recovery nor can there be one.The powers that be think that the cure for a debt problem is more debt the reason for this is that they are benefitting from the paper Ponzi scheme.
    Why any institution is investing in bonds with negative real and nominal rates defies all logic it truly is the Emporers new clothes.
    This time is different in that many eminently qualified people like the bond King Bill Gross are speaking out giving warnings and the public has access to invaluable information from people like you Shaun.
    I was beginning to think they could keep this going for some time but events over the last week have convinced me that the dam wall is starting to give way.
    When this breaks it will happen so quickly there will be no time to react they should have acted in 2009 and changed the monetary system and crashed the debt market instead they have extended and pretended at expense of savers and pension funds I believe this to be a criminal act by those who run our economies.
    They are robbing the population to sustain the unsustainable,get your money out of the banking system before the paper ponzi melts down.

    • Hi PrivateFraser

      My argument has been for several years now that this is a trap. There is no exit policy and even worse economies are like junkies requiring ever bigger “hits”. The new hits are increased equity purchases (Japan) and Corporate Bond purchases (Europe).

      What has convinced you over the past week?

    • Bill Gross (appointed “Bond Guru”) has been speaking out on this issue since 2009. Trouble is here we are 7 years later and he’s still wrong!! Think about that…..

      • Hi Noo2

        Reuters reminded us of that this week..

        @ReutersJamie Jun 9
        4% – UK 10y yield in Jan 2010 when Bill Gross said gilts were lying on a “bed of nitroglycerine”.

        1.22% – UK 10y yield today, a record low.

  5. Alice didn’t know what to say to this: it wasn’t at all like conversation, she thought, as he never said anything to her; in fact, his last remark was evidently addressed to a tree — so she stood and softly repeated to herself:
    ‘Humpty Dumpty sat on a wall:
    Humpty Dumpty had a great fall.
    All the King’s horses and all the King’s men
    Couldn’t put Humpty Dumpty in his place again.’

  6. This situation has called into question the concept of “money” and whether it has any value.

    I now think it entirely possible that respective Governments end up completely monetising the entire financial system. If this happens I can’t see how the bond bubble can burst as Governments pass money between themselves borrowing and spending for “free”, forcing investors into equity markets whilst hapless pension funds, themselves funded by regulatory contributions from employees under the “Workplace Pension scheme” in countries like the UK continue reducing annuity rates as a result of their legal obligation to buy Sovereign debt (although they may be able to turn a profit on the second hand sale of their bonds once the price is driven higher again).

    This can work indefinitely unless money velocity picks up, then the inflationary shock will make the Weimar Republic inflation experience look like a gentle fairy story……

  7. Great blog, Shaun, as always.
    I have just terminated my own crusade against the distortion of Canadian fiscal policy under the Conservative government by the TVO program The Agenda. (TVO is a public broadcaster, controlled by the Ontario government.) I finally got them to add a correction to the video on their website and the yahoo website although I couldn’t get them to issue the apology they should have. I hope the BBC has higher journalistic standards. TVO maintained that their charts were accurate right up until the point that the CBC file they had used as their source admitted that their charts were in error and corrected them, although it couldn’t have been more obvious that they were wrong.(The CBC Ombudsman, Esther Enkin, intervened on my behalf to get the CBC to correct its file.) The people running The Agenda obviously don’t know the difference between constant dollar spending and a man of constant sorrow.

    • Sorry, I meant to say that “right up until the point that the CBC admitted that the charts in the file they had used as their source were in error”. More haste, less speed.

      • Hi Andrew and thanks.

        You had better luck than me when I challenged the BBC World Service on a point of fact about Greece a few years ago. On and on it went until it ended up with the BBC Trust. The person who decided the case had a qualification in complaints management but was apparently able to decide against me on a technical bond market issue!

  8. Shaun,

    the current situation seems to me to be viewed in the future in the same way we look back at the tulip mania…how could THOSE people be so crazy as to pay so much for tulip bulbs??? how could US people be so crazy to accept, even SEEK negative yielding bonds?? This is my definition of a bubble: when people do things so obviously illogical, but cook up some explanation that satisfies them, for a time… Until “realness” sets in, and then the world is restored to natural order and common sense.

    A “House of Pain” lies between here and there, as it did in Holland so long ago.

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