Government Bonds with Negative Yield?

Readers,

I just read this

https://english.kontan.co.id/news/uk-sells-first-government-bond-with-a-negative-yield

I quoted the whole news:

Britain sold a government bond that pays a negative yield for the first time on Wednesday – meaning that Britain’s government is effectively being paid to borrow as investors agreed to be paid back slightly less than they lent.

The bond, which matures in July 2023, sold at an average yield of -0.003%.

While investors will receive an annual interest payment of 0.75%, they paid above face value for the bond so the actual return in cash terms is less than they have lent.

Demand for the bond was low by recent standards, with investors bidding for just over twice the £ 3.75 billion (US$ 4.59 billion) on offer.

The last time a bid-to-cover ratio was below Wednesday’s 2.15 was on March 19, before the BoE announced it would buy an extra 200 billion pounds of assets, mostly government bonds, to support the economy through the coronavirus crisis.

This is interesting news, though it is not really coming as a big surprise.

What does it mean?

It means that UK government bonds carry coupon rate lower than the at-that-time-issued market interest rate, resulting to the market value of that bonds higher than its face value. Let’s say, the face value of that bonds is USD 100, then the investor is willing to buy that bonds at USD 103. In other words, the investor has purchased that bonds at premium.

Under normal condition, coupon rate of bonds will be set at the same rate of that market rate at the time of bonds issuance, giving rise to face value of bonds = market value of bonds.

The big fat question is why the investor is willing to pay the bonds higher than its face value?

Looking forward, the investor might predict that the UK demand in the future will be lower, putting the market interest rate declining in the long term. It might indicate that the demand will not that be strong in the economy, and the economy might be going to be weak. As the long-term interest rate is influenced by the demand vs supply, then from the investor’s perspective, he/she is willing to invest in government bonds with premium, expecting that the long-term interest market rate will be going down to that level lower than the bonds coupon rate.

How about Indonesia?

We need to look at the bonds market.

Source: http://www.ibpa.co.id/ (accessed on 21 May 2020)

Why we need to keep an eye on the bond market, regardless you invest in stock market or real estate.

As we learnt from macroeconomic class, interest rate is the mother of economy. In the bonds market we could find the bonds yield, and as you probably already knew, the interest rates and bonds yields are highly correlated  (though it doesn’t mean that it always move perfectly in step), and oftentimes, even both terms are used interchangebly.

This is why it is so important for the investor to always look to bonds market, as interest is one of the leading economic indicators and bonds market could be considered as a great “predictor” of future economic activity and expected future levels of inflation. Both interest and inflation, as we know, had, is and will always directly affect the price of everything in the economy, running from capital market, real estate market, and domestic household demand.

Back to the bonds yield pattern above, for Indonesia, it is still displaying normal curve, which have expected long-term rate higher than short-term rate. While short-term rate is more driven by the announcement by the Central Bank, yet the long-term rate reflects the market forces, supply vs demand and the underlying expectation. This “expectation” is one key element in the determination of the long-term interest rates that is largely a function of the effect the bond market players believes current short-term interest rates will have on future levels of inflation.

Guided by this bond yields with its a normal yield curve which starts with low yields for lower maturity bonds and then increases for bonds with higher maturity, then the market players foresee that Indonesia demand will still be strong, including its inflation being high in the long-term eyes. To me, this makes economic sense, in view of the large population that Indonesia have.

I’ll give you simple math to see this.

Currently, Indonesia has around 267 million population (with 133 mio of working people). Assuming we take a very floor assumption, which one people will spend around Rp 25,000 per day only for basic needs such as rice, sugar, salt, vegetables, cigarette, coffee, etc.

Then the “real” money flowing will be :

267 mio (I rounded it up to 270 mio for convenience) x Rp 25,000/ day x 365 days = Rp 2,500 Trillion.

WOW!!!

This Rp 2,500 Trillion is only for the scenario for the basic needs consumption.

So readers, you could see the real domestic consumption strength in Indonesia, which in statistic, this massive and gigantic domestic demand have support Indonesia GDP growth more than 50% for years. I believe, this carries explicit confidence in the economy growth in Indonesia.

We need to be able to keep our eyes on the forest and not confused by the trees in between.

Though not really apple-to-apple comparison, yet I always remember that in early 2000s when the internet bubble burst out, what we saw it was the financial bubble that burst, but not the internet market. Internet market even continued to make its growth dramatically after that explosive bubbles. Which reminds me that it is always important to see what is going on in substance. With all this covid-19 pandemic outbreak and its short-term shock to Indonesia economy, Indonesia economy will still be there for 270 million people.

Jakarta, 21 May 2020

Reading:

https://www.cohencpa.com/insights/articles/on-(yield)-curves-and-what-they-mean (accessed on 22 May 2020)

Posted in ARTICLES & VIDEOS, VALUATION.

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