Friday 23 September 2011

Negative Interest Rates?

"Inflation Bonds Are Sold With Negative Yield for First Time" said the New York Times in 2010.

The $10 billion auction of the five-year bonds sold at a negative yield of 0.550 percent, according to the Treasury Department....Bond prices rose, with the yield on the 10-year Treasury down to 2.53 percent from 2.56 percent late Friday.

How could this happen?

10 comments:

  1. This is fascinating that the confidence level in the markets have fallen to levels that reuire investors to pay money to hold US debt. A little over a month ago the US had it's first downgrade in history and the markets had their worst day since 2008. Now investors are paying to invest their money in the US. The uncertainty in the markets is terrible and with the Fed stating, "there are significant downside risks to the economic outlook;" One can only assume it is going to get worse. If I were in the markets at this time I would pay to hold US debt as well.

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  2. In the light of quantitative easing, investors expected higher inflation rate in the future. More specifically, the Federal Reserve was expected to purchase more bonds in November that year. As a result, people were willing to pay to held the bonds to protect themselves against inflation.

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  3. A negative yield indicates that the market expects inflation to rise more rapidly than interest rate. Denote y as the yield, T as number of years from now, DF(T) as the discount factor of year T. DF(T)=1/(1+y)^T. If y<0, DF(T)>1. It means present value of the investment in TIPS is less than its future value. The reason behind is higher inflation expectation due to Fed's debt reconstruction and concerns of QE policy. The principal of TIPS is linked with the inflation index. The interest and principal payments will increase if CPI rises. So the TIPS investors are actually paying the government for inflation protection or a bet on the relative growth rate of inflation against interest rate. They think value of TIPS will deteriorate less than other bonds if inflation picks up.

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  4. This could happen because investors are demanding bonds so much, that the price is getting driven up. There is very little, if any, certainty in the markets now, and investors want to put their money somewhere.

    This is also do to other factors such as Europe's problems, and the American credit downgrade. European investors are looking for safe investments, driving demand of US bonds. Also, when the US got downgraded, investors still saw it is a AAA country, so demand (and prices) rose, driving rates down. In theory, the AA+ rating should have made rates slightly higher, due to America's new riskiness.

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  5. As people predict that inflation rates are more likely to rise in the future (due to policy of quantitative easing) people tend to favor more stable securities with the least amount of risk. There is a flight to quality in an insecure market and people are willing to pay extra to protect against inflation.

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  6. Similar to what Chandi and Jonathan said, people are seeking out safe options in the international market. Although, from the American perspective it seems as though we are in serious trouble, other countries such as Greece, Italy, Spain and Portugal are much more worse off. People are looking to move their investments from these countries into safer options. A US treasury bond being a great example, especially with barely any rate of return.

    This may be seriously detrimental though that the interest rate is negative if Interest rates rise too quickly. that could put us into a second recession which was created by the Fed and the government.

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  7. As mentioned by Jordan above, I believe that the reason why there is a negative yield curve is the expectation of higher inflation in the future. This can also be caused by a flight to quality. Meaning that the investors were heading toward less risky stocks which caused the yield curve to have yield.

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  8. This is because people know the inflation is going to be higher in the future. People want to invest their money in safety places such as government bonds which are less risky than other kinds of bonds. Bonds' prices go up because the demand is higher than the supply.

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  9. It's interesting that only the government has sold inflation-indexed bonds, not private corporations (though I know it is not only the US government; the British government was doing it even earlier).

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  10. On the whole it makes sense because what we have seen in the past few years is the fall of several markets that in the past were thought of as infallible. When these things occur people get nervous and begin to shift all of their money into more secure investments. As the demand for bonds has increased (especially long term) their price rises and the yield is obviously much lower.

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