below@zero.bound

Yes, finance has been witnessing a whole new world order at below the lower bound with more number of bonds now throwing negative yields and the ‘interesting’ part is that they are actually selling, meaning that there are buyers and investors who are buying them. Years together we have been hearing economists on the right side of the zero arguing about the thresholds of the bound. However, we can now believe that yields can still go freewheeling much below or to the left of the zero. Finance thus opens up to another act, this time to the left of the zero on the number line.

In the aftermath of the sub-prime crisis and the contagion that followed, the natural reaction was the prolonged period of easing by the central bank i.e. literally printing money to buy bonds so as to spur the economic engines with loans that were now made available at very cheap rates (esp. in the US, the Japan and the Euro areas). However the effects of the prolonged zero rates may or may not work at all for stimulating economy which is evident from the Japanese example.

But as you know the bonds prices and yields are negatively correlated, no one ever thought about the relation when the yields themselves would see the negative zone. The logical question’s that seems to be following would be like: What should happen to the price of the bond? Who should be buying them? What could be the reasons to buy a negative interest yielding instrument when you could simply stay put in cash?

In the Keynesian view interest could be seen as the reward for parting with money and so does the liquidity preference relationship stands. It is true that at a very low interest yield people would stay liquid by stuffing the cash under the mattress rather than to invest. However, this behavior seems to be challenged when today the bonds (a relatively illiquid asset) are yielding negative interest rates and are still finding investors.

The behavior for going with bonds that yield negative interest rates could then be explained with the help of another set of investor preference such as the ‘time-preference’ rather than the ‘liquidity-preference’. It is also worrying if this time the investors may hold the negative yield earning bonds in expectation that there would be more such downfall in the negative territory. The late economist Irving Fisher postulated in his theory that the interest rates result from the interaction of two forces i) time preference that people have for capital now and ii) the investment opportunity principle, that investment now will yield more returns in the future. However, when costs and security issues for handling cash become enormous investor may pay bank some interest for safeguarding the cash and prefer to earn negative returns. Where does this freewheeling in the negative territory stops? Currently no one knows, as the curious bond investors and the central bankers are still watching.

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