James Hamilton provided us with another interesting discussion on negative interest rates:
we now have several years of experience from Sweden, Denmark, Switzerland, Japan, and the European Central Bank in which the central bank successfully induced negative interest rates in hopes of stimulating a greater level of spending on goods and services.
Please read the entire post including some interesting comments. Alas I must be late to the party as I could not provide a reply to an interesting query from Barkley Rosser:
Does anybody have an explanation as to why when a nation has negative nominal target interest rates it often seems that the time horizon of government securities that end up having the most negative rates are often at the two years time horizon? Look at the Sweden case, where this has been the case, and it has also been in quite a few other nations as well. I have yet to see an explanation of this peculiarly non-monotonic yield curve in this situation so often.
Maybe Europe has turned Japanese. I’ve been looking at an Excel file of their government bond rates provided by the Ministry of Finance (not the Bank of Japan). Japan had low but not negative interest rates before 2012 with a somewhat upward sloping term structure. Since 2012, two features describe this data: (1) one-year rates hovering around zero – sometimes positive and sometimes negative; (2) two-year rates hovering near the one-year rate and it times just below them. What is driving this? I have no answer.
The negative rates are simply the TBTF ledger fees exposed. The fees should be made explicit.
We had fewer active terms on the curve, we were in contraction. We were not doing one year planning at the time, instead we were waiting for TBTF to be fixed, TBTF system failed in the last recession.
The issue here is who determines term length? Underneath finance, like GS, is swapping bonds on the run and constructing the actual yield curve. Remember, the curve we see is the one released by the primary dealer, not the one TBTF uses. . TBTF is a monopoly value added chain, here is really no free exit and entry so the average trade cannot really trade the nominal yield curve.
The TBTF theory is accepted by the Fintech industry, we intend to create a TBTF bank that runs automatically. Anyone who reserves the proper liquidity can play, it will be no longer limited to specially approved government banks. When we get that running, then the nominal yield curve will match the real yield curve, terms length become a variable. Then, if you want a fixed term length, you buy insurance to cover the drift.
I’d guess that this is the effect of “option premium” being embedded in short term interest rate pricing. There are very few markets where it’s balanced views between hiking and cutting these days due to forward guidance. Now it’s a matter of pricing how fast a CB will achieve whatever it has said it’s trying to achieve.
In the case of countries with negative rates, they’ve mostly also issued fwd guidance to the effect that they could cut more, or do more extreme policy, to try and “committ” themselves around the zero lower bound problem.
In that case, market participants won’t allow any spread of interest rates in the shorter part of the curve to go to 0 exactly – there will always be an option value to paying a spread of forward rates if the question is “what probability is there that the CB moves in that time” ? That way, even if everyone believes the CB will not actually go – there will still be a downward sloping forward curve for a market where it’s clear that the CB is only moving in one direction.
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