ultra low / negative interest rates in Germany

[barrett]

Wow! That REO Speedwagon music video has to be one of the worst I have ever seen!

Can we pull the discussion back to Pfanni's Dilemma? Would anyone on here buy 30-year bonds that were yielding 1.08%? My solution in a super low interest rate environment would be to go with more cash. But I've said that before. At 1.08%, doesn't the interest rate risk overwhelm the potential for long bonds to really perform as they are supposed to in the PP?

Cash is good to have if we have true deflation. And I'd love to see this discussed because it's not totally inconceivable (no Princess Bride tangents, please!) that we US PPers could find ourselves in a similar position within a couple of years.

[jafs]

It seems certain that cash is good if there's current deflation.

I'm not sure why long term government bonds would do well in that scenario - you'd have to believe there'd be deflation when the bonds mature, wouldn't you?

And even most forecasters don't predict things thirty years out with any sort of confidence.

[bedraggled]

Would zero-coupon bonds help in a low rate environment?

[MediumTex]

Would zero-coupon bonds help in a low rate environment?

All zeroes do is give you more volatility.  The rate environment doesn't matter.

[bedraggled]

Would Harry like zero-coupon volatility in this low rate environment?

I believe such oppositional volatility fits well here.

[MediumTex]

It seems certain that cash is good if there's current deflation.

Yes.  If prices are falling and cash is getting more valuable, you want to have some cash for sure.

I'm not sure why long term government bonds would do well in that scenario - you'd have to believe there'd be deflation when the bonds mature, wouldn't you?

Deflation creates a set of expectations in the market in terms of trends.  If the market is seeing deflationary forces in the future, it will push down yields on bonds, which make the bonds more valuable for people who already own them.  If I buy a 30 year treasury bond that pays 5%, and the market starts to think that deflationary forces are going to push future interest rates down, current yields will begin falling, and if interest rates on 30 year treasury bonds go down to 4%, my 5% bond will have seen a very nice increase in value, which is a completely separate matter from the coupon payment.

And even most forecasters don't predict things thirty years out with any sort of confidence.

Actually, they predict it with a lot of confidence, they are just often wrong.

One thing that is rarely wrong, though, is the bond market.  Trends in the bond market tend to be pretty stable for LONG periods of time.

You really ought to check out the PP book linked to in the banner at the top of the page.  The book was written for people like you, and it walks you through the exact kind of questions you are asking about each PP asset, along with how the PP assets are designed to work together.

[jafs]

Thanks - that's a good answer.

[MediumTex]

Would Harry like zero-coupon volatility in this low rate environment?

I believe such oppositional volatility fits well here.

The low rate environment doesn't matter.  All that happens as rates get lower is that smaller interest rate moves show up as greater fluctuations in value in the underlying bond.  With zeroes, you get more price action movement based on the same fluctuation in interest rates when compared to a coupon bond.

For example, if I buy a 30 year bond paying 10%, and interest rates fall to 9%, I will see a gain in the value of my bond.  If, however, I buy a 30 year bond paying 2%, and interest rates go down to 1.8%, I might actually see a greater increase in the value of my bond, even though it was based on a much smaller interest rate move.  In terms of bond pricing, this is known as yield curve "convexity." 

If you use zeroes, all of this same stuff happens, it just happens with more volatility in the value of the underlying bond.  Go compare a chart of TLT and EDV and you will see what I am talking about.

See picture below for a visual representation of the convexivity of the yield curve.

[img width=500]http://cafemutual.com/test/635106884781120000_qq.png[/img]

I think that bond traders prefer low interest rate environments because small interest rate moves can trigger large gains.

I always think of a very low interest environment in the bond market as sort of like a game of tennis turning into a game of ping pong.  Everything gets faster and tighter the smaller the court becomes.

[Pfanni]

I know about bond convexity.
But 1.01% on a 30 year bond in a questionable currency (EUR) remains a sh*tty deal.
So as a EUR citizen with a Permanent Portfolio I have four options now:

1) Take the sh*tty deal (30yr 1.01% EUR German gov bond).
2) Hope & pray for currency appreciation in a better currency (Switzerland 30yr CHF 0.29%).
3) Aim for the highest yielding AAA gov bond (USA 30yr 2.69%), hope for the best.
4) Go to EUR cash, buy a bigger mattress for when banks start to charge retail customers negative rates in the foreseeable future.

There are no good options on the table anymore. They all suck in a way, big time.
USD seems the way to go for now. Big outlier, G3 AAA currency with this high a yield.

[belgo]

Hi, I am in the same position than you having to decide about this issue and I share your frustration. But after reading the book, I understand better now that you need the 30y bond to protect you against the scenario of deflation "irrespective of the current rate".  And one could argue that even at 1% there is upside, e.g. look at the current CHF 30 year you quote.  If there is an alternative way of protecting the portfolio against deflation I would be very interested to consider it.
If we do not buy this deflation protection the PP does not work in my opinion. And maybe the EUR is questionable but if we hold German bunds we are in the best position in case the EURO would blow up.  Buying CHF bonds instead does seem attractive but involves currency risk.  When I started working in Switzerland the EURCHF rate was at 1.52.  EURCHF dropped to 1.00 last year and is at 1.11 today.  Who knows what CHF will do in the future?

[economicsjunkie]

Hi
German government bonds have negative rates up to 7 years now.

1 year: -0.44%
7 year: -0.05%
30 year: +1.08%

I refuse to buy a 30 year bond yielding 1%. I just refuse to do that. No thanks.
Physical EUR cash seems better and better for half the PP portfolio (cash & bond portion).

Does anybody have an idea for European PP investors what to do?

I can understand where you're coming from. At some point the upwards punch that long term bonds offer seems kind of exhausted. For example, with rates at 1%, if rates were to drop to 0 or something slightly negative (unlikely for 30yr bonds, but even if it were to happen it can't keep going indefinitely), the maximum upwards potential is around 30% in price appreciation, plus some coupon payments, so maybe 35% or so during a 5 year deflation/depression for example.

And what if rates are at 0.45% for 30 year bonds, a level they have reached in 2015? Your maximum upwards potential there is more like 14-20%.

Is there a point at which bonds can't deliver what they need to deliver in the PP?

[Kriegsspiel]

If bonds "can't" deliver gainz, then I'd guess stocks or gold would. If not, we're fucked probably. Unless aliens came to save us in their giant starship.

[economicsjunkie]

If bonds "can't" deliver gainz, then I'd guess stocks or gold would. If not, we're fucked probably. Unless aliens came to save us in their giant starship.

Stocks wouldn't in a depression/deflation, but I was thinking along the same lines re/ gold. Maybe when bond returns get this low, gold will play a much more important role as default go to asset when people sell stocks, and thus deliver the necessary punch. Gold has historically performed well during the Great Depression and the Great Recession; maybe it'll perform even better when the longest term yields approach zero?

[Pfanni]

The fundamental issue with the EUR 30yr bonds 1% yield is this:
Does it reflect the market's view?
Is it a true market event or a central bank scam?

The answer should be clear.
It is not market participants buying deflation protection.
It is the central bank buying these bonds to the tune of 50 billion / month.

It is a scam. A farce. A hustle. A lie.
And I for one am not gonna be the bag holder.

[Libertarian666]

The fundamental issue with the EUR 30yr bonds 1% yield is this:
Does it reflect the market's view?
Is it a true market event or a central bank scam?

The answer should be clear.
It is not market participants buying deflation protection.
It is the central bank buying these bonds to the tune of 50 billion / month.

It is a scam. A farce. A hustle. A lie.
And I for one am not gonna be the bag holder.

Exactly.

[Pfanni]

Did I write 1.08%?
I mean 0.96% yield on 30yr German gov bond this very morning.

I used to game convexity and I made some money on yields collapsing last year.
I have the utmost respect for people trying to make money off this central bank scam.

But for the long term, buy & hold portfolio, 0.96% don't fit.

--------

I like this site to look at yields:
http://pigbonds.info/Staatsanleihen/Deutschland

(I hope it's ok to post this link here).

[economicsjunkie]

But for the long term, buy & hold portfolio, 0.96% don't fit.

I'd be curious to see how Japanese PP investors have done over the past 17 years or so, their rates hit very low levels around 1999 and 2004 already.

[Lang]

You can try and use a US PP instead, but I strongly advise you to hedge the currency. Deflation usually increases a currency's value, so unless you hedge, you could have major losses. On the other hand, hedging has its cost too - probably somewhat below 1% a year for EUR/USD. But IMO it's worth it.

[lordmetroid]

But for the long term, buy & hold portfolio, 0.96% don't fit.

I'd be curious to see how Japanese PP investors have done over the past 17 years or so, their rates hit very low levels around 1999 and 2004 already.

Chart of Japanese PP from 1992 to 2012:
[img width=500]http://4.bp.blogspot.com/-jLZBJlSnvMI/U ... _Japan.png[/img]
Source: http://gestaltu.com/2012/09/the-permane ... nese.html/

As can be observed, the permanent portfolio isn't all that permanent outside of the United States.

[economicsjunkie]

But for the long term, buy & hold portfolio, 0.96% don't fit.

I'd be curious to see how Japanese PP investors have done over the past 17 years or so, their rates hit very low levels around 1999 and 2004 already.

Chart of Japanese PP from 1992 to 2012:
[img width=500]http://4.bp.blogspot.com/-jLZBJlSnvMI/U ... _Japan.png[/img]
Source: http://gestaltu.com/2012/09/the-permane ... nese.html/

As can be observed, the permanent portfolio isn't all that permanent outside of the United States.

Very interesting. I have to say that this is in my opinion still a remarkable performance, given how Japanese stocks and real estate have performed in that same period.

[craigr]

Did I write 1.08%?
I mean 0.96% yield on 30yr German gov bond this very morning.

I used to game convexity and I made some money on yields collapsing last year.
I have the utmost respect for people trying to make money off this central bank scam.

But for the long term, buy & hold portfolio, 0.96% don't fit.

--------

I like this site to look at yields:
http://pigbonds.info/Staatsanleihen/Deutschland

(I hope it's ok to post this link here).

Pfanni,

I agree that long bonds under 1% are a poor value and it's very unlikely I'd hold them myself either. We are discussing some of these scenarios on this thread for those interested:

http://gyroscopicinvesting.com/forum/bonds/bond-upside/

U.S. bonds are still holdable for me personally. But there is a point where dogma and reality intersect and reality needs to take precedence. This brings up sticky questions like when to buy back in for Europeans that sell their bonds to exit the game. But I understand the dilemma for them in terms of risk vs. reward with such low interest rates.

U.S. investors haven't had to cross that bridge yet. Personally, at 1% on long bonds I'm selling them and I know that breaks the portfolio model, but that's just my number where I don't think the long bonds are going to do much more vs. the risk of loss. I'd rather go short on the yield curve and just suck it up for a while.

For Europe though, the situation is quite different and each person has their own circumstances. Others are welcome of course to share their ideas on what they are doing if they are investing in that arena today.

I don't want to get too much on a tangent either, but what Merkel is doing to the EU with her immigration madness is a serious red flag for the stability of the EU as a whole. Bonds from the EU and even Germany if it continues on this course are looking like very bad buys for Europeans and they should consider looking outside the region as one alternative. I would also seriously consider geographic diversification of assets if those investors haven't done it already.

[economicsjunkie]

Very interesting conversation, thanks for linking craigr.

[Pfanni]

Hello Craig
thanks for tuning in. I actually bought & read your book
I fully agree with you on the pointlessness of holding 1% 30yr EUR bonds.

I was thinking of replacing the bonds with more of the other elements for the time being (stocks, gold, cash 33% each).
I am sure others have thought of this before me.
Has anybody done any sharpe ratio calculations, return calculations etc on this yet?

--
Of course Merkel's immigration policy is insane. I have to live in the midst of this, unfortunately.
I personally know two refugess from Libya. One has a narcotics problem and deals with stolen smartphones. Showed up with a swollen lip. My (Christian) family wanted to help this guy but we terminated the contact as soon as we heard about his criminal activities.
The other one is a very nice person, also from Libya.
But the cold, hard facts are that none of them has any valuable qualifications. They were the kids of farmers back home. They lived in a rural area, ploughing fields. There is nothing wrong with that. But with this background you will never make a living in a first world economy. You will always be a net drain on society. Of course, we don't want to kick them out either, with Islamic State taking hold around the town of Sirte.
German state budget (all levels of government + EU) is around 600 billion EUR. 80 billion EUR is being spent on pensions. Now the refugees cost us at least 50, probably closer to 60 billion EUR per year. If no additonal refugees arrive (not gonna happen). That's a cool ten percent of total government revenue! That's where it gets insane.

[LazyInvestor]

Yes, I think EU people should have a Bogleheads style portfolio with 10% or so gold.. not PP.. something like 40% short/intermediate treasuries, 10% gold, 50% total world market.

EU bonds suck, the relationship between Euro and gold is not the same as USD and gold, immigration, crazy welfare systems, people obsessed with as short work weeks as possible, etc.

[ochotona]

So in the US, if interest rates get to the point of diminished returns, maybe swap out 10 year bonds instead of 30? Or even shorter? 5-7 year? What do people think?