How Sub-Zero Government Bonds Turned the Hunt For Yield Upside Down

Negative yields haven't actually benefited European credit markets for the past 2.5 years, argues Credit Suisse.

The erosion of yields on government debt is generally thought to push investors into riskier assets as they seek out higher returns.

That's true, argue Credit Suisse AG analysts in a new note, but only in the 'first phase' of a negative yield world. That is, when yields on government bonds with shorter-durations dip below zero, total returns on riskier assets such as junk-rated corporate debt do trump returns on German bunds.

Source: Credit Suisse

That tendency disappeared, however, as yields on longer-dated government debt also fell into negative territory — at least in Europe.

"The defining characteristic of Phase One is a strong outperformance of high-yielding credit assets versus low-yielding credit assets and government bonds, i.e. a strong hunt for yield trend. Nothing unusual so far," write Credit Suisse's William Porter and Chiraag Somaia. "However, more interestingly, Phase Two, still characterized by negative yields, actually sees an outperformance of government bonds versus both low- and high-yielding credit assets, i.e. any hunt for yield over the past 2.5 years as a whole has been an unsuccessful strategy."

The trend is shown in the below chart, where total returns on German government bonds have bested high-yield and investment-grade corporate debt.


"For now, we think ever-falling yields represent an overall risk aversion and/or verdict on economic policies that is not overly friendly to yieldier assets despite the obvious incentives they carry in this environment," conclude the analysts. "So yield-hunting behavior is not always and everywhere wrong — this summer may treat it favorably — but any outperformance has subsequently been counter-trend in the past 2.5 years."