Europe: When losing money makes sense

NEW YORK (CNNMoney) -- There is a remarkable trend developing in European bond , where investors are increasingly willing to money to certain governments in exchange for next to .
In the most extreme example, yields 2-year German bonds turned negative this week, falling to a record -0.5%. That means, in at least, investors could end losing money if they hold the bonds maturity.

Germany is eurozone's largest economy and its bunds are considered the safest assets available for investors are expecting the worst. But the flight to safety is becoming widespread as investors hunt a marginally better return.

This week, 2-year yields briefly negative for France, while Denmark and Switzerland are more firmly below zero. Short- yields for AAA-rated Finland and the Netherlands fell record lows.

The trend reflects a heightened aversion risk as Spain and Italy struggle to avoid victim to the crisis that dragged down Greece, Portugal and Ireland. Yields on bonds by Italy and Spain rose this week as investors demand higher premiums to hold debt is considered risky.

"The rise benchmark yields in say Italy and Spain to worryingly high levels shows a concern amongst many participants about fiscal sustainability," said Andrew Milligan, head of global strategy Standard Life Investments.

The yield, or interest , on a bond falls when prices rise. A negative yield means investors effectively paying the government to take money.

"The analogy I use is that it's like putting money under the ," said Schwab fixed-income strategist Kathy Jones. "Investors trust the core countries and -euro countries to return their money, if it costs them something."

Some analysts say the surge demand for short-term, ultra-safe bonds is to moves by the European Central Bank, recently cut the rate it pays banks to hold money overnight to zero.

Without getting a yield the ECB, banks that want a safe place to park their money are looking . And that means "the short-dated debt of the least risky economies in the single currency ," said Nicholas Spiro, director of London- consultancy Spiro Sovereign Strategy.

There is another reason the move helped drive down yields this week, said Tobias Blattner, a ECB economist who now works at Daiwa Capital Markets in London.

The deposit rate serves a floor for money market funds, he said, many of stopped accepting inflows this week.

"Investors who normally park money those funds need to put it somewhere else," said Blattner. Short-term bonds by AAA-rated governments, are safe and liquid, are one of the main alternatives, he added.

The drop in short- French bond yields this week represents a significant change in market sentiment President François Hollande, who to power in May by campaigning against government austerity.

"For , investors are giving Hollande the benefit of the ," said Nick Stamenkovic, fixed-income strategist RIA Capital Markets in Edinburgh.

his heated campaign rhetoric, Hollande has a more moderate approach since the election, said Antonio Barroso, an analyst political research firm Eurasia Group.

"Overall, the strategy of Hollande regarding fiscal consolidation seems to be of incrementalism and anticipated damage control," Barroso wrote in a note clients. "The president knows that despite the current positive market environment, the pressure French sovereign debt could return any moment."


Adapted from: CNN Money, July 13, 2012.