Negative Bond Yields?

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ericcohen
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Negative Bond Yields?

Post by ericcohen » Sun Mar 24, 2019 6:09 pm

I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?

Geologist
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Re: Negative Bond Yields?

Post by Geologist » Sun Mar 24, 2019 6:32 pm

If you are a large financial institution and you have 1 billion euros to invest, you can't stick it in a mattress in your bank, so you need to buy government bonds.

ohai
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Re: Negative Bond Yields?

Post by ohai » Sun Mar 24, 2019 6:42 pm

QE type operations are a big part of it. ECB is buying European government bonds on a regular schedule regardless of price. Even if this drives prices above par value, there's nothing they can do about it.

Another reason might be that other places to store money are considered unsafe or just inconvenient. Imagine a scenario where all European banks are on the edge of bankruptcy and you're not confident that they will keep your money safe. Then, perhaps you might consider lending to the German government at negative interest, since you believe they will not default.

You might not be able to avoid negative rates, even if you wanted to. In a deflationary environment, all short term interest rates could be negative. However, it's not like you can withdraw all your money and keep it in paper bills. You still have to deposit it somewhere.

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Re: Negative Bond Yields?

Post by Trader Joe » Sun Mar 24, 2019 7:23 pm

ericcohen wrote:
Sun Mar 24, 2019 6:09 pm
I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?
No, individual investors should not invest in these offerings.

Angst
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Re: Negative Bond Yields?

Post by Angst » Sun Mar 24, 2019 8:15 pm

ericcohen wrote:
Sun Mar 24, 2019 6:09 pm
I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?
Links? What was said in those articles? A little context would be helpful and links would be appropriate.

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dmcmahon
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Re: Negative Bond Yields?

Post by dmcmahon » Sun Mar 24, 2019 8:36 pm

https://www.schwab.com/resource-center/ ... cmp=em-QYB

Japan has slightly negative 10 year rates, the other countries you mentioned have negative rates at 2 years but not at 10 years.

Large institutional and corporate investors may be stuck taking negative rates, because they can’t park large amounts of cash in any other way. Large pension funds and insurance companies may also have to take such investments to preserve their portfolio allocations.

typical.investor
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Re: Negative Bond Yields?

Post by typical.investor » Sun Mar 24, 2019 8:42 pm

ericcohen wrote:
Sun Mar 24, 2019 6:09 pm
I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?
Vanguard recommends and includes them in their retirement funds actually.

The key is currency. Vanguard's fund is hedged, so actually those negative yield German and Japanese bonds have positive yields for US investors.

Even for German and Japanese bond holders though, negative yields may net positive return. Deflation is generally expected to strengthen currencies. And conversely inflation long term will weaken it. So while those German and Japanese investors could buy US bonds and benefit from the higher yield (and they do - sometimes borrowing as low rates and investing in higher paying foreign bonds), there is a risk currencies will adjust.

Of course individual investors don't have the regulatory requirements that large institutions do and which forces them to buy no matter what.

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Re: Negative Bond Yields?

Post by JackoC » Sun Mar 24, 2019 9:18 pm

dmcmahon wrote:
Sun Mar 24, 2019 8:36 pm
https://www.schwab.com/resource-center/ ... cmp=em-QYB

Japan has slightly negative 10 year rates, the other countries you mentioned have negative rates at 2 years but not at 10 years.

Large institutional and corporate investors may be stuck taking negative rates, because they can’t park large amounts of cash in any other way. Large pension funds and insurance companies may also have to take such investments to preserve their portfolio allocations.
The German 10 yr went negative the other day, as part of the reaction to a series of bad economic reports various places related to Friday's stock sell off. Other Eurozone issuers have significantly higher yields because there's significant perceived credit risk, a statement you can't necessarily make comparing bond yields in different currencies.

People with very little savings whose expenses will be in EUR, JPY etc don't need to invest at negative yields, they can hold currency. But the relatively unusual 'average' here, investors with say $100k's at least, don't necessarily have much more choice than banks do if negative rates prevail on safe bonds in their currency of future liabilities. Just because safe bond yields yield slightly negative doesn't mean it's wise to have 100% of your money in stocks or risky bonds, and investing in govt bonds in other currencies (unhedged) has currency risk. OTOH just like for example today in the US the best 5yr CD rate yield is 1.2% more than the 5 yr treasury (albeit that's wider than usual) there could be opportunities to put money in essentially govt risk for slightly positive yields even if direct govt obligations were at slightly negative yields.

But in general just because you don't like what the market returns doesn't mean it 'owes' you more or there's some way around it to the return you want. This is also relevant in the US as when people conclude they'll just up their stock allocations because bonds don't yield 'enough'. That could easily end in tears (some people might have good rationales for very high stock allocations and know themselves enough to sustain it, but I often wonder if all the people espousing that after years of good stock returns and still lousy, though not negative, US bond yields are really acting wisely).

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Re: Negative Bond Yields?

Post by jn6474 » Sun Mar 24, 2019 9:50 pm

The idea of lowering bond yields is simply to stimulate the economy, make borrowing money cheaper and holding onto money more expensive (or less appealing). Thats how you get people to spend and borrow more, investing it wont earn you anything and borrowing is cheaper (or in this negative scenario, you actually get paid to borrow). That would motivate me to start that business, i now can borrow money to start it with a negative borrowing cost. It also motivates me to potentially spend it now, rather than paying to hold onto it. This theoretically stimulates the economy and leads to higher inflation.

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Re: Negative Bond Yields?

Post by AlohaJoe » Sun Mar 24, 2019 9:59 pm

Geologist wrote:
Sun Mar 24, 2019 6:32 pm
If you are a large financial institution and you have 1 billion euros to invest, you can't stick it in a mattress in your bank, so you need to buy government bonds.
You don't even need a billion Euros. What if you have €125,000? That's above the deposit insurance limits. Do you trust the bank not to have any haircuts or other problems?

Or what if your bank starts charging you negative interest? Do you pay negative interest to the bank or to the government? I know of one German company that was being charged negative interest by their bank and I assume they weren't the only one.

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Re: Negative Bond Yields?

Post by pdavi21 » Sun Mar 24, 2019 10:20 pm

IIRC, Nestle and Shell have sold bonds with a negative yield at one point.

If the bond yield goes more negative, a speculator could sell for a profit. So that's one reason.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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gmaynardkrebs
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Re: Negative Bond Yields?

Post by gmaynardkrebs » Sun Mar 24, 2019 10:41 pm

Is a negative rate bond one that is sold for $X that pays $ .9X at maturity?

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Re: Negative Bond Yields?

Post by fennewaldaj » Sun Mar 24, 2019 11:09 pm

AlohaJoe wrote:
Sun Mar 24, 2019 9:59 pm
Geologist wrote:
Sun Mar 24, 2019 6:32 pm
If you are a large financial institution and you have 1 billion euros to invest, you can't stick it in a mattress in your bank, so you need to buy government bonds.
You don't even need a billion Euros. What if you have €125,000? That's above the deposit insurance limits. Do you trust the bank not to have any haircuts or other problems?

Or what if your bank starts charging you negative interest? Do you pay negative interest to the bank or to the government? I know of one German company that was being charged negative interest by their bank and I assume they weren't the only one.
There is a point where renting a vault to store physical currency would make sense I guess.

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Re: Negative Bond Yields?

Post by JackoC » Mon Mar 25, 2019 8:27 am

gmaynardkrebs wrote:
Sun Mar 24, 2019 10:41 pm
Is a negative rate bond one that is sold for $X that pays $ .9X at maturity?
Generally the other way around, 1000 currency units worth of bonds pays that amount at maturity but is issued for greater than 1000 if it has a negative yield. Some govt's include a small positive coupon for operational reasons even on bonds originally issued at negative yield, other times it's zero.

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Re: Negative Bond Yields?

Post by jeffyscott » Mon Mar 25, 2019 11:21 am

typical.investor wrote:
Sun Mar 24, 2019 8:42 pm
ericcohen wrote:
Sun Mar 24, 2019 6:09 pm
I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?
Vanguard recommends and includes them in their retirement funds actually.

The key is currency. Vanguard's fund is hedged, so actually those negative yield German and Japanese bonds have positive yields for US investors.
Is this because Vanguard currently gets paid for their hedging of those currencies or is this dependent on favorable changes in currency exchange rates?
Time is your friend; impulse is your enemy. - John C. Bogle

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Re: Negative Bond Yields?

Post by LadyGeek » Mon Mar 25, 2019 3:01 pm

ericcohen - Has your question been answered?
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Re: Negative Bond Yields?

Post by robertmcd » Mon Mar 25, 2019 3:13 pm

Dependent on currency exchange rates. Hedged to USD those german and japanese bonds may yield more than US treasuries. You could have asked - Why would a Japanese investor want to buy negative yielding US debt?

If after accounting for currency hedging the yield is still negative, you may still want to buy negative yielding debt in the event of deflation. In the case of 3% deflation, a -1% bond has a positive yield of 2%

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Re: Negative Bond Yields?

Post by JackoC » Mon Mar 25, 2019 4:01 pm

jeffyscott wrote:
Mon Mar 25, 2019 11:21 am
typical.investor wrote:
Sun Mar 24, 2019 8:42 pm
ericcohen wrote:
Sun Mar 24, 2019 6:09 pm
I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?
Vanguard recommends and includes them in their retirement funds actually.

The key is currency. Vanguard's fund is hedged, so actually those negative yield German and Japanese bonds have positive yields for US investors.
Is this because Vanguard currently gets paid for their hedging of those currencies or is this dependent on favorable changes in currency exchange rates?
It is because currently the *interest rates* prevailing on short term forward FX rates are higher in USD by roughly as much as US treasury yields exceed high grade EUR (eg German) and JPY govt bond yields. What you lose on the yield of the bond you get back in carry profit on the hedging FX trades*. That's not always true. In recent years before the Fed raised short term US rates much above zero there was not a big difference in rates on either side of a USD/EUR or USD/JPY short term fwd FX trade. But US treasuries still yielded significantly more.

Let's assume a USD investor and also assume everything equilibrates so the FX hedged return on foreign bonds is similar to the return of US treasuries. Why would you jump through hoops to get back to that same return? Only if you feel US govt credit risk, while undoubtedly good, is not so extremely good that you can totally neglect diversification of credit risk. There are very good muni and corporate credits, but you don't put *all* your bond money in any single one of them. Some people think US federal credit is so good it defies that rule and you can put *all* your bond money into it. Others aren't sure. That's the main reason IMO to consider currency hedged foreign govt bond funds. There might be some diversification of rate risk too but that seems secondary to me.

If OTOH you're an EUR based investor German bunds (or some other minor northern Eurozone countries but not France's or Italy's) are the 'riskless' asset. As mentioned the FX rate differential will work in the other direction right now and make US treasury yields hedged into EUR pretty much zero also. Simply taking unhedged USD risk to get the full 2.some % is an additional risk. One might not like negative yields, and say without fully thinking it through 'oh I'd never invest in that', but what else would you actually do if an EUR based investor with EUR100's k and didn't think 100% stocks was appropriate? You might find nearly govt type risk at slightly higher yield (at least not long ago there were slightly positive interest rate bank accounts in European countries with central bank rates <0), but basically you have to accept what the market offers.

*these funds are hedged by taking all the present value in a given currency and offsetting that by selling that amount for settlement some days forward. When that forward date becomes spot, they roll the trade forward by buying back that FX amount for spot and selling again some days forward. The carry profit/loss on those trades depends on the short term interest rates on each side in the FX market. The relationship between those rates on either side can be significantly different than the relationship of several yr govt bond yields on each side, but is currently broadly similar.

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Re: Negative Bond Yields?

Post by jeffyscott » Mon Mar 25, 2019 4:30 pm

JackoC wrote:
Mon Mar 25, 2019 4:01 pm
One might not like negative yields, and say without fully thinking it through 'oh I'd never invest in that', but what else would you actually do if an EUR based investor with EUR100's k and didn't think 100% stocks was appropriate? You might find nearly govt type risk at slightly higher yield (at least not long ago there were slightly positive interest rate bank accounts in European countries with central bank rates <0), but basically you have to accept what the market offers.
Basically that, as an individual I'd accept slightly higher risk and/or use some sort of bank account, if there were one paying 0% or better. Pretty much did that as well as put money into I and EE bonds to avoid the near 0% rates that we had in the US. We do have to ultimately accept what the market offers, but don't have to accept what it offers from any particular borrower (such as the Federal government).

Thanks for explaining in detail how the hedging works.
Time is your friend; impulse is your enemy. - John C. Bogle

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Re: Negative Bond Yields?

Post by Iridium » Mon Mar 25, 2019 6:39 pm

ericcohen wrote:
Sun Mar 24, 2019 6:09 pm
I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?
Consider the alternatives for money you want to keep perfectly safe:

Cash: Insurance companies charge somewhere between 0.25 - 1% to insure cash in a vault. There is a far higher transaction cost to carry around trucks of cash vs. electronically recorded bonds. Even though dollar bills carry an interest rate of 0, it may still makes sense to pay a little bit for putting the money in a form that is more convenient to deal with and cannot be readily stolen.

Bank: Institutions have difficulty managing vast sums under FDIC and equivalent limits. Also banks were starting to charge negative interest in their bank accounts to institutions.

Money Markets: Not perfectly safe but also paid negative interest.

What else? If you had massive amounts of money in Europe/Japan, you either had to take risk or pay money to 'store value'.

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ericcohen
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Re: Negative Bond Yields?

Post by ericcohen » Mon Mar 25, 2019 6:45 pm

LadyGeek wrote:
Mon Mar 25, 2019 3:01 pm
ericcohen - Has your question been answered?
Sure has. Some very informative answers. thanks.

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Re: Negative Bond Yields?

Post by anoop » Wed Aug 14, 2019 12:39 am

If US treasuries go to below zero, what should be the strategy for an individual that mostly buys treasuries? Find something else to buy like CDs? Live with the negative yields? Buy gold?

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Re: Negative Bond Yields?

Post by Lee_WSP » Wed Aug 14, 2019 12:45 am

anoop wrote:
Wed Aug 14, 2019 12:39 am
If US treasuries go to below zero, what should be the strategy for an individual that mostly buys treasuries? Find something else to buy like CDs? Live with the negative yields? Buy gold?
The bond fund itself would increase in value, so holding it while rates continue declining is advantageous. Moreover, you will continue to receive the same dividends from the fund, although they will decline over time as old bonds are replaced with newer bonds.

So, doing nothing is a viable strategy. Should you put more money into bond funds? It depends if you think rates will continue to decline. However, a better way to look at it is to look at the SEC yield and decide if that's good enough for you or not. If it is, you'll be fine; you will receive that rate over the average duration of the bond fund. If you aren't happy, look elsewhere, but there may be no other option.

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Re: Negative Bond Yields?

Post by anoop » Wed Aug 14, 2019 12:52 am

Lee_WSP wrote:
Wed Aug 14, 2019 12:45 am
anoop wrote:
Wed Aug 14, 2019 12:39 am
If US treasuries go to below zero, what should be the strategy for an individual that mostly buys treasuries? Find something else to buy like CDs? Live with the negative yields? Buy gold?
The bond fund itself would increase in value, so holding it while rates continue declining is advantageous. Moreover, you will continue to receive the same dividends from the fund, although they will decline over time as old bonds are replaced with newer bonds.

So, doing nothing is a viable strategy. Should you put more money into bond funds? It depends if you think rates will continue to decline. However, a better way to look at it is to look at the SEC yield and decide if that's good enough for you or not. If it is, you'll be fine; you will receive that rate over the average duration of the bond fund. If you aren't happy, look elsewhere, but there may be no other option.
I have been buying individual issues and holding to maturity. Because rates were increasing, I was focused on maturity < 2 years.

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Re: Negative Bond Yields?

Post by Lee_WSP » Wed Aug 14, 2019 12:55 am

anoop wrote:
Wed Aug 14, 2019 12:52 am
Lee_WSP wrote:
Wed Aug 14, 2019 12:45 am
anoop wrote:
Wed Aug 14, 2019 12:39 am
If US treasuries go to below zero, what should be the strategy for an individual that mostly buys treasuries? Find something else to buy like CDs? Live with the negative yields? Buy gold?
The bond fund itself would increase in value, so holding it while rates continue declining is advantageous. Moreover, you will continue to receive the same dividends from the fund, although they will decline over time as old bonds are replaced with newer bonds.

So, doing nothing is a viable strategy. Should you put more money into bond funds? It depends if you think rates will continue to decline. However, a better way to look at it is to look at the SEC yield and decide if that's good enough for you or not. If it is, you'll be fine; you will receive that rate over the average duration of the bond fund. If you aren't happy, look elsewhere, but there may be no other option.
I have been buying individual issues and holding to maturity. Because rates were increasing, I was focused on maturity < 2 years.
Missed the individual treasuries part. Just buy the instrument that yields the highest yield. Even easier answer.

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Re: Negative Bond Yields?

Post by MoneyMarathon » Wed Aug 14, 2019 1:30 am

typical.investor wrote:
Sun Mar 24, 2019 8:42 pm
The key is currency. Vanguard's fund is hedged, so actually those negative yield German and Japanese bonds have positive yields for US investors.
To attribute expected return to currency hedging, one would have to assume that the dollar is expected to continue to gain relative strength to other developed market currencies in the long run, indefinitely.

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Re: Negative Bond Yields?

Post by typical.investor » Wed Aug 14, 2019 3:00 am

MoneyMarathon wrote:
Wed Aug 14, 2019 1:30 am
typical.investor wrote:
Sun Mar 24, 2019 8:42 pm
The key is currency. Vanguard's fund is hedged, so actually those negative yield German and Japanese bonds have positive yields for US investors.
To attribute expected return to currency hedging, one would have to assume that the dollar is expected to continue to gain relative strength to other developed market currencies in the long run, indefinitely.
Huh? Either I misunderstand you, or that is factually incorrect. I suspect the latter.

Hedge yield is determined by the difference in interest rates.
(bond) hedging provides investors with an alternative stream of returns that is distinct
from both the currency return being hedged and the return of the underlying bonds
https://personal.vanguard.com/pdf/ISGHC.pdf

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Re: Negative Bond Yields?

Post by Valuethinker » Wed Aug 14, 2019 3:41 am

Iridium wrote:
Mon Mar 25, 2019 6:39 pm
ericcohen wrote:
Sun Mar 24, 2019 6:09 pm
I've been reading some financial articles about German and Japanese 10 year bonds offering negative yields. I can't understand why anyone would buy those bonds. Can someone explain how it would makes sense for anyone to buy these negative yielding bonds?
Consider the alternatives for money you want to keep perfectly safe:

Cash: Insurance companies charge somewhere between 0.25 - 1% to insure cash in a vault. There is a far higher transaction cost to carry around trucks of cash vs. electronically recorded bonds. Even though dollar bills carry an interest rate of 0, it may still makes sense to pay a little bit for putting the money in a form that is more convenient to deal with and cannot be readily stolen.

Bank: Institutions have difficulty managing vast sums under FDIC and equivalent limits. Also banks were starting to charge negative interest in their bank accounts to institutions.

Money Markets: Not perfectly safe but also paid negative interest.

What else? If you had massive amounts of money in Europe/Japan, you either had to take risk or pay money to 'store value'.
I vaguely recall that when the European Central Bank started paying negative rates on deposits from Eurozone banks, Commerzbank considered simply putting cash Euro notes in its vaults (0% return is better than a negative return) for its excess deposits (that it could not lend, or was not allowed to lend for regulatory liquidity reasons).

In doing this, Commerzbank would have soaked up all the cash in Germany, if not the whole Eurozone.

So the regulators pretty quickly quashed this idea.

One Japanese financial institution, whose members are all agricultural co-ops, owns 10% of all the CLOs out there and 18% of the AAA tranches. CLOs are our old friend the CDO (The Big Short, etc) but backed by, typically, private equity buyout type loans (LBOs). Mostly issued in the USA.

One institution has accumulated one tenth of all of these securities. Shades of the German financial institutions which piled into CDOs at the top of the 2000s market.

This is what happens when you have long term zero interest rates -- banks chase risk up the curve.

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Re: Negative Bond Yields?

Post by MoneyMarathon » Wed Aug 14, 2019 11:32 pm

typical.investor wrote:
Wed Aug 14, 2019 3:00 am
MoneyMarathon wrote:
Wed Aug 14, 2019 1:30 am
typical.investor wrote:
Sun Mar 24, 2019 8:42 pm
The key is currency. Vanguard's fund is hedged, so actually those negative yield German and Japanese bonds have positive yields for US investors.
To attribute expected return to currency hedging, one would have to assume that the dollar is expected to continue to gain relative strength to other developed market currencies in the long run, indefinitely.
Huh? Either I misunderstand you, or that is factually incorrect. I suspect the latter.

Hedge yield is determined by the difference in interest rates.
(bond) hedging provides investors with an alternative stream of returns that is distinct
from both the currency return being hedged and the return of the underlying bonds
https://personal.vanguard.com/pdf/ISGHC.pdf
Thanks, that's the first I've seen that explains that idea.

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