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Australian Government Bonds in negative return territory

Here is a link to the Australian Government's Office of Financial Management.

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Ever since Kevin Rudd/Wayne Swan started to hit the market up for money to pay the government's bills, the AOFM has put out regular tenders (or calls) for money in return for various Australian Government bonds.   The Government then typically accepts the best offer (or cheapest) source of money.

The usual rule in borrowing money is that you have to pay for it.  The Australian Government has always done so - that is until last week.

Submitted by Simon Black via Sovereign Man blog,

Let’s talk about idiots.

Somewhere out there, some absurdly well-paid banker just placed his investors’ capital in yet another financial instrument which is guaranteed to lose money: Australian government debt.

47 investors participated in the Australian government’s $200 million bond tender; the participants typically bid the amount they’re willing to pay, and the highest bids win the auction.

In this case, and for the first time in Australia, every single one of the 47 bidders offered a price so high that it implies a negative interest rate.

Even the lowest bid in the auction, for example, implied a net loss… or an effective yield of NEGATIVE 0.015%. The highest price implied a yield of negative 0.085%.

What’s really bizarre is that this particular issue was for ‘inflation-linked’ bonds. Which means that if the government’s official monkey math shows that inflation is falling, the yield could actually become even MORE NEGATIVE.

Insane? Of course. But here’s the thing. These bankers aren’t investing their own money.

It’s not like some guy is taking his million dollar bonus and saying, “Hey I think I’ll go buy some government debt that guarantees I’ll lose money.”

No. He buys a Maserati. Then he picks up this garbage debt with his customers’ money.

Not only is this idiotic, it’s borderline criminal. At a minimum it’s seriously unethical.

Banks and other money managers have a solemn obligation… a fiduciary responsibility that comes with the sacred charge of safeguarding other people’s money.

Just like the golden rule, this obligation is very simple: take care for other people’s money even more than you care for their own.

But that went out the window a long time ago.

and here is the more prosaic Australian Financial Review:

Australian bonds print first ever negative rate

by Jonathan Shapiro

Australia has this week joined the illustrious list of governments that have been able to borrow money at negative interest rates.

The Australian Office of Financial Management, which manages the government's debt programme, sold $200 million of inflation-linked bonds maturing in 2018 to 13 investors on Tuesday at a yield of -0.0763 per cent. It was the first time the government set the price of a new bond that implied a negative return for investors.

At Tuesday's auction of 2018 bonds investors bid the bond price up so that the implied rate was slightly below zero. This meant investors were paying up because they expect the Reserve Bank of Australia to cut the current cash rate of 2.25 per cent to below inflation, which is currently at 1.7 per cent.  

Investors pay a price to own the bonds and in return get a rate of 1 per cent plus a rate linked to the Consumer Price Index, which they receive when the bond matures in 2018. Excluding the gains tied to the inflation rate, they would get less back than their initial investment.

The "inflation-linked bonds" are distinct from more common nominal bonds and reflect expectations of 'real', or inflation-adjusted rates available in the market. These bonds, known as 'linkers' pay a fixed rate of interest, but subsequent rates, and the final amount due to investors on maturity is adjusted periodically to reflect moves in the consumer price index measure of inflation.

Westpac's head of bond and inflation trading Andrew Barrelle said that the negative yields on inflation linked bonds are a reflection of "very low cash rates and easy monetary policy".

"It's a reflection that the market expects the cash rate will go to 2 per cent and possibly below. If you take the 2018 nominal bond yield of 1.80 per cent and an inflation expectation of 2 per cent – which is the bottom of the [Reserve Bank's target] band, you will end up with a negative real yield of -20 basis points," he said. 

"If the RBA does ease rates to 2 per cent or below and inflation expectations went up you could get a situation where the real yield moves more negative."


Any expert opinion most welcome. 

UPDATE - here's one such opinion from reader M

Dear Michael,

The item posted by you about the recent issue of Government Bonds and their astounding auction price is much more scary a thing than we may have seen in our lifetimes, lifetimes that have seen a lot of scary stuff.

It's about money.
There are only two (2) sources of money (wealth).
It comes from:
1. YOU at work
2. YOUR MONEY at work
For those who still are able to work, you will be OK (so long as you are at work).
For those who can no longer work you must survive on the second option only-You need to have some money to put to work. (It used to be called superannuation).
As you begin to put your money to work you find that there are only two (2) ways to make it work.
1. In EQUITY ( e.g. shares- in something active)
2. In DEBT. (lend it to someone who promises to pay you for the privilege-it used to be called usury or interest - bank deposits e.g.)
Interest rates or acceptable usury is and are already at historic lows. Your money will not return you too much at all now.
If you rely on shares then they should not be in funds that have a lot of bonds or similar devices making up the expectancies as they are always historically lower in yield (offset by the sovereign guarantees they offer)
When bonds sell at auction for less than face value the sovereign guarantee gets blown out of the equation, negating the reason you bought them in the first place. You have been dudded at this point.
Without confidence an economy grinds to a halt. No growth. Stagflation.
No interest yields.
Nowhere to put your money to work.
Big scary problem. The signal has been given at this auction.
Did anybody know what the starter's gun required them to do?
Does anybody understand the race they must now run?
Answers to these questions may make interesting reading.