Are Negative Yield Treasury Bonds Likely in the U.S.?

When discussing the possibility of the U.S. Treasury issuing bonds with negative yields, it's important to understand the dynamics at play. Unlike the common perception, the Treasury doesn't directly determine the yield on its bonds. Instead, this is determined by the bidding process among potential buyers.

Understanding the Bidding Process

When the U.S. Treasury issues bonds, it conducts auctions where potential buyers submit bids based on what they think these bonds are worth. For a bond to be issued at a yield of zero or negative, the potential buyer would need to bid its face value or higher. This is a rarity unless there is an unimaginable abundance of available cash, which typically arises from severe economic conditions like a stock market collapse. Even then, the demand for treasuries may not be sufficient to push the prices above their face values.

Factors Influencing Yield

In the market, the yield on a Treasury bond is inversely related to its price. A bond trading at a price higher than its face value results in a negative yield. This occurs because the total cash flows from the bond (including interest payments and the face value at maturity) are less than the purchase price. This situation can happen if market conditions drive up the price of the bond significantly higher than its face value.

The Role of Economic Conditions

The likelihood of Treasury bonds having negative yields is closely tied to broader economic conditions. Events such as central bank policies, global economic trends, and market sentiment all play a role. For instance, if the Federal Reserve lowers interest rates to zero and further to negative levels, it sets the stage for negative yields. This has already occurred in some countries, as illustrated by Kenneth Rogoff, a prominent economist, suggesting that negative rates are a necessary tool when interest rates reach zero.

Practical Examples and Insights

To illustrate the concept of negative yield bonds, consider a scenario where a bond promises to pay $2 per year for ten years, plus a face value of $100 at maturity. The total cash flow from the bond is $120. If this bond trades at a price of $100, its yield is 2%. If it trades at a price of $120, its yield is zero. Should the price of the bond exceed $120, the yield would become negative.

Conclusion

While the notion of the U.S. Treasury issuing negative yield bonds might seem far-fetched, it is not entirely without precedent. The likelihood of this occurring is largely dependent on specific economic scenarios such as a stock market collapse leading to a deluge of available cash. However, given the current economic stability and market conditions, the probability is quite low. As the economy evolves, one can never fully rule out the possibility of negative yields becoming a reality.