Some goverment bonds (Japanese, German, Swiss) are yielding negative rates. So basically shorting them would give you a cash flow with limited downside and a potential big gain.

Tell me why not to short these bonds?

If price is expected to go down, it is acceptable to short the instrument, but
the Bond price is inverse to the yield curve...

Two caveats !

1. there is the 'hoover' of ECB that is buying some of those instruments
and that is pushing lower the interest rates, and increasing the asset prices
of those bonds

2. there is the consequene of reduced liquidity in some of these instruments
how to deal with this, if a short squeeze is to occur and 'forced delivery' is to
occur ?


regards,
ron

rleplae 

If price is expected to go down, it is acceptable to short the instrument, but the Bond price is inverse to the yield curve... Two caveats ! 1. there is the 'hoover' of ECB that is buying some of those instruments and that is pushing lower the interest rates, and increasing the asset prices of those bonds 2. there is the consequene of reduced liquidity in some of these instruments how to deal with this, if a short squeeze is to occur and 'forced delivery' is to occur ? regards, ron

1) Yeah but how low can yields go? Even sub-zero rates seem irrational, let alone high below-zero rates. It will never be -5% or even -2% for that matter. Anything below -1,5% is just plain ridiculous.

2) I though government bonds are the most liquid intruments in the world.

As an additional note: I suppose establishing a short position would only be possible (but it is possible) through the derivatives market. Which is great since you can also get nice leverage...

In some sovereign debt instruments the liquidity has significantly dropped, because
the ECB has been vacuum cleaning the market and there is just not that much left
to be bought in some cases...

While I agree that the market conditions are 'special' and 'exagerated', that exageration
period can take a few years before normalizing and even get worse... in which case a
significantly leveraged derivate position would just kill you..

rleplae 

In some sovereign debt instruments the liquidity has significantly dropped, because the ECB has been vacuum cleaning the market and there is just not that much left to be bought in some cases... While I agree that the market conditions are 'special' and 'exagerated', that exageration period can take a few years before normalizing and even get worse... in which case a significantly leveraged derivate position would just kill you..

Any position with too much leverage can kill you regardless of the time horizon.

“There is absolutely no reason why we would need to buy bonds with a negative yield in the short-end, it’s just crazy,” Rantala said by phone

An $18 Billion Finnish Bond Fund Tells Why It?s Fleeing the ECB - Bloomberg

So, there's nine trillion in Japanese money fleeing the negative interest rates on JGBs. Where is it gonna go?

Treasury 30-Year Yield Seen Near Zero in Nomura?s Vicious Circle - Bloomberg

If the old adage was "don't fight the Fed", then you could also probably say "don't fight the ECB", or at least (very seriously) "don't fight Draghi". Trichet had much less credibility or bravado to confront markets in my opinion.

As long as the liquidity pumping continues, yields should fundamentally head lower. With something like the Fed QE2 program, shorting the bonds was an easier proposition compared to QE3 since there was a deadline attached to when the faucet would turn off. Here with the ECB, even though they have a stated deadline, they also have a very clear forward guidance of a 'potentially' more open policy depending on future conditions.

If you can correctly predict the timeline of the shift in policy, then that turning point is when you would start shorting the negative yielding instruments. That's simply stating the obvious trillion dollar question - when will the yield curve flip back over. If thinking about going short short, I'd probably short against the European negative yielding debt versus the Japanese given the time horizon of the QE program difference.

Until then, maybe a better idea would be to be more strategic on hunting the weakest in the pack, even if it is not negative yielding yet, e.g. shorting Italian 10 year debt. With the Bund, you still risk a flight to safety trade, but there is no such thing as flight to safety to Italian debt in the current environment. Or better yet, deploy the a spread trade of long US debt and short the Italian 10, etc.

Anyways, just some food for thought. Standard disclosures, do your own analysis, understand liquidity risks, etc, etc, etc.

Yuri57 

Some goverment bonds (Japanese, German, Swiss) are yielding negative rates. So basically shorting them would give you a cash flow with limited downside and a potential big gain. Tell me why not to short these bonds?

To quote a well known phrase

Because the market can stay irrational longer than you can stay solvent.