The case for buying negative yield bonds

Danish Khan | E+ | Getty Images

Buying negative-yield bonds -- or paying for the privilege of lending money -- might look like a sucker's game, but some analysts see the opportunity for profits.

"Is it strange for you to buy negative-yield bonds? Probably not," said Nizam Idris, head of strategy for fixed income at Macquarie.

It's about playing the currency, he said.

The FX effect

"If you bought Swiss bonds at the end of last year, you'd need to pay a negative rate, but the currency appreciated 30 percent," Idris said. "If you expect Danish central bank to do same thing [and unpeg its currency from the euro], then it would make sense to put money into Danish bonds." Denmark also has negative interest rates.

Read More Why some bond investors don't mind losing money

Markets were caught off guard earlier this month when the Swiss National Bank (SNB) canceled its over three-year-old policy pegging the exchange rate of the euro buying 1.20 Swiss francs. In response, the franc surged, with the common currency fetching as little as 0.86 franc in the immediate aftermath. In early Asia trading Wednesday, the euro was buying 1.03 francs.

The SNB also cut interest rates deeper into negative territory, by 50 basis points to negative 0.75 percent, in an effort to help cushion the blow. The move spurred speculation that Denmark's central bank may also depeg its currency; it's already cut its interest rates deeper into negative territory to counter pressure from a falling euro in the wake of the European Central Bank (ECB) launching a quantitative easing program.

Even though more than 70 percent of Swiss government bonds are now subject to negative rates, the SNB is likely to cut its benchmark rates even further into negative-land, possibly by as much as 50 basis points, Nomura said in a note Monday. That implies further gains for its bonds; bond prices move inversely to yields.

Choose wisely

To be sure, some of Germany's and Japan's bonds are also at negative yields and not many expect either the yen or the euro to appreciate anytime soon.

That may be driven, at least in part, by fear of both declining asset prices and potential deflation.

Read More Why Denmark won't 'pull a Switzerland'

In that case, "you [would] want to make sure you get your money back," Idris said.

Warped demand

Central banks' quantitative easing measures are also warping demand for sovereign bonds.

In Japan, bond yields face a demand squeeze, Yasunari Ueno, chief market economist at Mizuho Securities, said in a note last week.

Even as the Bank of Japan is buying Japanese government bonds (JGBs) in huge volumes and foreign investors are also coming back into the market, "Japanese investors are holding huge amounts of surplus yen funds that they need to place," he said. "With no consistent sellers, the market is dominated by buyers."

Japan's short-term yields, of less than three years, turned negative last year, and earlier this month, the five-year JGB slipped close to zero several times.

The aging population may also be playing a role in investors continuing to chase bonds, even when it doesn't appear to make sense.

"If impending old age is the issue, it can be very difficult to convince households via lower rates to shift desired consumption from the future into the present," Steven Englander, global head of G-10 foreign-exchange strategy at Citigroup, said in a note Tuesday. "They are targeting a certain level of income from savings, and the lower returns go, the more they save."

Deflation bets

To be sure, there are certainly risks that bets on continued deflation will turn bad.

For one, the ECB's use of quantitative easing to fight potential deflation may be misplaced, Chris Rupkey, chief financial economist at MUFG Union Bank, in a note last week.

"They may really just be chasing the temporary drop in world oil prices. Once oil stops falling deflation goes away. Poof. Like magic," he said.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1