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In these tumultuous times, compounded by a brewing crisis in the Euro-zone, demand for investments that have traditionally provided shelter from the damages of more "volatile" and "uncertain" times are on the rise. This phenomenon is especially observable in bond markets, at least for those sovereigns that are not perceived to be "drowning" in their debt.
As a matter of fact, the uncertain times, which is behind the strong demand for "safe" government bonds has created a situation where risk premiums have turned negative. This is because as nominal yields have dropped steadily, inflation has remained constant or is even rising, depending on which figures you use.
Take treasuries as an example. The average rate of inflation calculated by taking the consumer price index figures (CPI) from 1914 to 2011 amounts to about 3.25%. If we subtract this from the nominal yield rates of treasuries, the real yield turns out to be negative. The more worrying part of this observation is the fact that real yields are negative throughout all maturities which means that even if you were to hold 30 year treasuries, your return would be expected to be negative (the purchasing power of your capital will be shrinking every year!).
Negative yields are a boom for borrowers because it means that they can borrow very cheaply. The cost to the investor, however, should be an incentive for them to take on more risk, especially in an environment where returns are getting increasingly hard to come by. This is not happening and pundits that have been forecasting an end of the rally of bonds since 2007 have been consistently proven to be wrong. Not enough investors are moving their money out of treasuries to make yields go in the opposite direction. This could be reflecting sentiment that is highly bearish regarding the future which is not surprising when we look at the way in which the sovereign debt crisis is being handled in Europe.
