EURO GOVT-Bunds rise as Germany sells debt at negative yields
Negative 2 year rates emerging in Europe
Yesterday Germany auctioned off 4.17 billion euros of zero-coupon bonds at a negative yield. This type of search for safety in the credit markets in Europe lead me to believe that equity investors either think the debt crisis is solved (via central banks willingness around the world to pump the system full of liquidity) or that equity investors have become complacent about risk (ie: VIX at 16)
What kind of investor would pay $1 to get back $0.99?
One explanation could include institutions that need to be invested in high quality sovereign debt. Since Moody's downgraded Italy last week, we could be seeing some rotation out of Italy and into German debt. If you needed to be invested all the time, then I believe that is plausible explanation. However, if you didn't need to be invested why not just leave the money in a German bank? Well some investors may think that paying a negative yield plus the spread above USTs is analogous to the theta decay in a call option. You know that your initial outlay is your maximum loss (in this case the initial outlay is the negative yield plus spread over USTs), but if there is a breakup of the Euro than you have a two year call option on being paid back in a currency that is much more valuable. If the negative yields were just occurring in Germany than I could buy the argument that we are seeing this action as a result of investors needing to be fully invested, and since Italy is the second largest debt market in Europe, investors are naturally rotating into other regions that can absorb Italy's overflow. However, we are also seeing negative yields in the smaller, higher quality sovereigns in Europe as well. The Dutch and Finnish two year bonds have also entered negative territory. Could this be a disconnect between debt and equity investors' perspectives on the likely endgame for Europe?
http://in.reuters.com/article/2012/07/18/markets-bonds-euro-idINL6E8IIH9F20120718