The Structure and Meaning of Negative Interest Rate Sovereign Debt

A familiar item, the humble US Savings Bond, will serve as my concept model to explain sovereign debt, also known as government debt.There is a difference; not important to discuss right now.

A US Savings Bond can be purchased at any bank in the United States, on the spot. The investor pays, say, $17.50 for a bond with $25 face value. When the bond matures, n years later, it can be cashed in for the full face value. This is known as the discount for buying the bond and holding it, and it is the sum total of your return at maturity. (1)

Because the US Savings Bond is backed by the full faith and credit of the US Treasury, it is considered a top-flight storehouse for cash assets. (2) Government-backed securities like the US Savings Bond are also known as sovereign debt(3); debt issued by a national government. Other US government-backed securities aka sovereign debt are Treasury Bonds.

The global economy is running on empty. Interest rates cannot be raised. If governments raise prime interest rates, it will trigger an upward adjustment in all credit markets. The upward adjustment will tighten credit markets and further stifle already weak consumer demand. Therefore, a severe global depression looms within the next year.

It’s easy to see why. Countries like Japan are now charging people more than the face value of the sovereign debt instrument. So you pay $17.50, + a 1.75 interest fee on top of that. The nation is not paying you a premium to buy and hold their bonds, you are paying the nation a premium. Thus, to you, it is negative cash flow, therefore a negative interest rate.(4) Those bonds, held to maturity, will not yield the face value.

Other large national economies have offered negative interest rate bonds within the last year.

“With other options to stimulate the economy limited, more policy makers are willing to test sub-zero rates, while accepting that they can lead banks to take additional risks in search of profit.

“The ECB has charged banks 0.3 percent to hold their cash overnight since December. Sweden also has negative rates, Denmark is using them to protect its currency’s peg to the euro and last year Switzerland moved its deposit rate below zero for the first time since the 1970s.

“Janet Yellen, the U.S. Federal Reserve chair, said in November that a change in economic circumstances could put negative rates “on the table” in the U.S. Since central banks provide a benchmark for all borrowing costs, negative rates spread to a range of fixed-income securities. By the end of 2015, about a third of the debt issued by euro zone governments had negative yields, and by February more than $7 trillion of government bonds worldwide offered yields below zero.” (5)

Conclusion: there’s really big money looking for very safe places for storage of fungible liquid assets like cash. Big rich countries are the storehouses for wealth in bad times and they intend to profit from that status.

 

CC BY 4.0 2016 Deborah Lagutaris

Just tonight, news arrives that New Zealand it cutting sovereign debt rates.

http://abcnews.go.com/International/wireStory/zealand-cuts-interest-rates-record-low-225-percent-37531067

By Deborah Lagutaris, March 9, 2016

Informal discussion post written for the course Chartered Portfolio Manager and Investment Management ITX 646 Winter 2016, Thomas Jefferson School of Law, George Mentz, Professor.

This entry was posted in Economics 101, Federal Reserve. Bookmark the permalink.

Comments are closed.