Scared investors pay interest to buy safe bonds

Market Analyze

(MoneyWatch) Europe's deteriorating economic situation has investors so nervous that instead of buying bonds which pay interest, they are paying interest to buy bonds which they consider safe. Both Germany and Switzerland held very successful auctions this week - even though the effective or actual rate the bonds would "pay" was less that 0 percent.

Earlier this week Switzerland sold $965 million of 91-day bills at a yield of minus 0.158 percent and $780 million of six month-bills at a yield of minus 0.318 percent. This is the second time this has happened in the last six weeks. On April 10 the rate for the six-month bills was minus 0.251 percent. This means investors are paying a full half percent more for someone to hold their money for them.

On Wednesday Germany sold $5.73 billion worth of two-year government bonds at a record low yield of 0.07 per cent. With inflation in the Eurozone running at 2.5 percent annually, the bonds have an effective yield of minus 2.43 percent. The 2-year German Schatz bond - which tracks bond futures - received $9.81 billion in bids at a sale of 0 percent bonds. This was $3.5 billion more than the government's maximum sales target of $6.37 billion. Also, the German 30-year bond fell below 2 percent for the first time since at least 1994.

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Following this, the German debt agency said it wouldn't sell bonds at a negative rate, but indicated it could sell more 0 rate bonds in the future.

Eugene Philalithis, portfolio manager at Fidelity Multi Asset Income Fund, says fear is driving investor actions. He told Reuters, "Issuing a bond with a zero coupon is a clear demonstration of the massive dislocation we are seeing in Europe. The flight to quality trade continues in earnest, sucking assets out of the periphery into the safest havens. ... Fear is the motivator, and until we see significant policy action from the European authorities we will continue to lurch from one stage of the crisis to the next, with ever more surprising and unexpected results."

If, as is likely, a lot of the money buying these bonds is being taken out of Spain, Italy, Portugal, Ireland and Greece, the flight to safety is actually adding to the EU's economic instability.

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    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald,, CSO, and Boston Magazine.