How can the 10-year real Treasury bond yield be zero, or negative?
That's like giving out money for free, right? Does that mean that people expect the value of the dollar to go up (deflation)?
Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It only takes a minute to sign up.Sign up to join this community
It can be zero or negative given the current market conditions.
Any money parked with treasury bonds is 100% risk free. So if I have a large amount of USD, and need a safe place to keep, then in today's environment even the banks (large as well) are at risk. So if I park my money with some large bank and that bank goes bankrupt, my money is gone for good. After a long drawn bankruptcy procedure, I may get back all of it or some of it. Even if the bank does not go bankrupt, it may face liquidity crises and I may not be able to withdraw when I want.
Hence it's safer to keep it in Treasury bonds even though I may not gain any interest, or even lose a small amount of money. At least it will be very safe.
Today there are very few options for large investors (typically governments and institutional investors.) The Euro is facing uncertainty. The Yuan is still regulated. There is not enough gold to buy (or to store it.) Hence this leads towards the USD.
The very fact that USD is safe in today's environment is reflected in the Treasury rates.
The interest rate offered by a bond is called the nominal interest rate.
The so-called real interest rate is the nominal interest rate minus the rate of inflation. If inflation is equal to or greater than the nominal rate at any given time, the REAL interest rate is zero or negative.
We're talking about a ten year bond. It's possible for the real interest rate to be negative for one or two years of the bond's life, and positive for eight or nine.
On the other hand, if we have a period of rising inflation, as in the 1970s, the inflation rate will exceed the (original) interest rate in most years, meaning that the real interest rate on the ten year bond will be negative over its whole life. People lost "serious" money on bonds (and loans) in the 1970s.
In such situations, the BORROWERS make out. That is, they borrow money at low rates, earn inflation (plus a little more) pay back inflated dollars, and pocket the difference. For them, the money is "free."
Supply and demand for a particular bond may be such that the market price exceeds the par value for the bond at maturity. This is when you get a negative yield. Especially when volatility is high, people will actually pay money to park it in treasuries for an amount of time. But when compared to a > 25% vol in the equities market over that same period, taking a 5% or less hit doesn't sound nearly as bad!
I'll get to my answer in a moment, but first need to put focus on the two key components of bond prices: interest rates and credit risk.
Suppose that the 10-year treasury has a coupon of 2% per year (it would be paid as 1% twice per year, in reality).
If you own one contract of the bond which we suppose has a so-called face-value of $100, then this contract will over the ten years pay you a total of $20 in coupons, then $100 at redemption. So $120 in total.
Would you therefore buy this 10-year treasury bond for $120, or more, or less?
Well, if there were bank accounts around which were offering you an interest rate of 2% per year fixed for the next 10 years, then you could alternatively generate $120 from just $100 deposited now (if we assume that the interest paid is not put back in the account to earn 2% per year). Consequently, a price of $100 for the treasury would seem about right.
However, suppose that you are not very confident that the banks that offer these accounts will even be around in 10 years time, maybe they will fail before that and you'll never get your money back. Then you might say to yourself that the above calculation is mathematically right, but not really a full representation of the different risks. And you conclude that maybe treasuries should be a bit more expensive, because they offer better credit risk than bank deposits.
All of this just to show that the price of bonds is a comparative valuation of rates and credit:
you need to know the general level of interest rates available in other investment products (even in stocks, I'd say),
you need to have a feel for how much credit risk there is in the different investment products.
Most people think that 'normally' interest rates are positive, because we are so familiar with the basic principle that:
if I lend you some money then you need to pay me some interest.
But in a world where everyone is worried about bank failures, people might prefer to effectively 'deposit' our savings with the US treasury (by buying their bonds) than to deposit their savings in the local bank. The US treasury will see this extra demand and put up the prices of their bonds (they are not stupid at the US treasury, you know!), so maybe the price of the 10-year treasury will go above $120. It could, right?
In this scenario, the implied yield on the 10-year treasury is negative.
There you go, yields have gone negative because of credit risk concerns.
As no one has mentioned them I will...
The US Treasury issues at least two forms of bonds that tend to always pay some interest even when prevailing rates are zero or negative.
The two that I know of are TIPS and I series bonds. Below are links to the descriptions of these bonds:
All of the other answers here are accurate, but (I think) are missing the point as to the question, which rests on how Bonds work in the first place.
The bond specifies a payback AMOUNT and DATE. Let's say it is $10,000 and one year from today.
If you buy that today for $9900, your yield will be 1%. If you buy it today for $11,000, your yield will be less than 0% (please don't make me do the math - it's just under negative 1%).
You might be willing to pay that 1% (rather than receive 1%) for the certainty that you will definitely get your money back. The combined actions of all the people who may be willing to pay a little more or a little less for the safety of a US Treasury Bond is what people call "the Market."
Market forces (generally, investor confidence) will drive the price up and down, which affects the yield.
All the other stuff - coupons and inflation and whatnot - all of that only makes sense if you understand that you aren't buying a rate of return, you are buying a payback amount and date.