On November 18, 2020, the Chinese government issued 4 billion Euros worth of debt at rock bottom yields. The star of this issuance was 750 million Euros of zero-coupon, five year maturity bond issued at a price of 100.763. The redemption of this paper at maturity will be at 100. In other words, this bond was issued at a negative nominal yield of -0.15%. And that excludes whatever inflation we might experience for the duration that might result in a lower “real” yield (Source: Financial Times, November 18, 2020). Yield hungry investors lined up to buy this bond, since, compared to the -0.50% on German Bunds, -0.15% looks like a deal!
In a number of articles in this forum written over a year ago (here, and here), I wondered in amazement that there would be such demand for negatively yielding, long term German government “Bunds”. Reality is even more amazing than imagination, and the issuance of the Chinese negatively yielding bond was met with investors lining up to pay money to the Chinese government for the mere privilege of lending. Now, technically investors don’t mail a check to the Chinese government. They simply pay more today than the par amount they will receive in the future. To be exact, for every 100 Euros they will (hopefully) receive in five years, they are willing to pay a little over 100.75 Euros today. The extra 0.75 Euros is where the negative yield comes from.
With the geopolitical troubles between the US and China now brewing for a few years, investors have been looking for signs of the Chinese diversifying out of their massive holdings of US debt that is held in Treasurys. So far, there has been little, if any, sign of sale of these Treasurys. Just as well, because the first large tranche of Treasurys that gets sold will likely be met by an anticipation by markets that more is to come, which could result in a huge impact on the price. With the Fed having adopted Modern Monetary Theory (MMT) in all but name, there is another reason for the Chinese to rationally not sell Treasurys – the US taxpayer, via the Fed, is buying them at higher and higher prices, to the tune of $120 billion a month! In other words, the US debt is essentially guaranteed to retain its nominal value.
Given this wonderful state of affairs for China, one of the best ways to diversify its holdings of forex reserves is to issue debt in Euros, and get paid for it at the same time! What they obtain is a large amount of Euros, which they have the option of just storing in a vault, at zero yield, or lending out at higher rates elsewhere if they choose to. Note the difference between a sovereign issuing foreign debt and a private enterprise issuing debt in a foreign currency with negative yields. A private enterprise would issue debt in Euros, and once the Euros are received, it has currency risk. If the Euro’s value fluctuates, it could end up owing more real value in the future when it has to redeem the Euros. Thus a private enterprise would have to hedge using the currency market, and the act of currency hedging would essentially negate a lot of the benefit of the low (negative) yields. A sovereign does not have this same constraint; the Chinese government has the long term goal of diversifying its currency reserves. So holding Euros and the currency fluctuations are actually beneficial and consistent with the diversification objectives. If the Euro weakens over the redemption period, they will redeem with fewer RMB. If the Euro strengthens, they can simply print more RMB to exchange for the Euros needed. This is the “magic” of MMT for sovereigns.
From the perspective of a market participant, this is simply brilliant global arbitrage. If every other sovereign with a printing press realizes that in the short term, you can get this “something”, for “nothing”, I expect much more issuance of Euro denominated low or negatively yielding bonds. This is simply an unintended consequence of the ostrich-in-the-sand-like behavior of the ECB, amongst other Central Banks, pushing interest rates negative and buying up negatively yielding bonds in Europe, helping flood the market with cash. Is it any wonder equities seem to defy gravity during a global pandemic?