A curious phenomenon is happening around the world: there is now $16 trillion worth of negative-yielding bonds in Europe and Japan. Until the last few years, this has never been seen in modern history, and only during 2019 has the amount of negative-yielding debt reached such heights.
Most Japanese and European government bonds, and even many of their corporate bonds, now pay negative effective interest rates. Investors essentially pay for the privilege of lending money to the government and to certain corporations, rather than getting paid to do so like lenders always have throughout history.
For example, here is a chart of the yield of the German 10-year government bond over the past year. It now offers a -0.68% annual yield to maturity:
This doesn’t mean that investors actually pay interest on a regular basis; it means that investors agree to pay a higher number, such as $105, for a bond that will be return just $100 to them in a decade. In other words, they are guaranteed to lock in a negative nominal return over a 5-year, 10-year, or even 30-year or longer period in some cases depending on the type of bond they buy. Switzerland’s 50-year government bonds have negative yields, as an extreme example. Investors are locking in five decades of negative returns.
The oddity of so much negative-yielding debt has been a prime topic in financial media lately, as various analysts, investors, and former central bank leaders discuss what such unusual bond markets could mean for the global economy.
One reason that European and Japanese stocks in the I Fund have underperformed over the past decade is that, in a zero or negative interest rate environment, their banks have found it very difficult to make money. Banks borrow at lower short-term rates (like deposits) and lend money at higher long-term rates (like mortgages), and that difference after expenses is the source of their profits. With ultra-low or negative yields across the interest rate spectrum, and a flat or inverted yield curve in many places of the world, it’s a challenging environment for European and Japanese banks.
In fact, European bank stocks are at lower levels today than they were a decade ago:
I’ve looked at this data over a longer period as well, and European bank stocks are actually where they were in the late 1980’s over three decades ago. Their bank stocks went up tremendously in the 1990’s and early 2000’s, but came crashing down during the global financial crisis, and have remained low ever since while U.S. bank stocks mostly recovered.
This has dragged down the performance of the I Fund for many years, because even though Europe’s non-bank companies have done well enough, their financial sector has gone down.
Fortunately, the TSP has no negative-yielding bonds at the moment, unlike some other index fund providers. For example, the LifeStrategy funds at Vanguard, which are very similar to the TSP’s Lifecycle funds, do have exposure to a lot of this negative-yielding debt because they specifically have an allocation to international bonds. The TSP invests only in U.S. bonds.
See also, Interest Rates Cuts and the G Fund
However, former Federal Reserve chairman Alan Greenspan and many others have pointed out that there’s nothing fundamentally stopping this phenomenon from potentially spilling over to the United States. If that were to happen, the G Fund and perhaps even the F Fund, could eventually experience negative interest rates. Whether this happens or not will depend on Federal Reserve monetary actions, U.S. and global economic growth, bond investor demand for perceived safe haven assets, and inflation rates, among other factors.