It’s been over a year since I last plotted the yield curve and a lot has happened since then. I updated the code slightly to convey a clearer visual. As expected, short-term rates have risen, as shown on the chart below.
We know that the yield curve is, inherently, a forecast for what the economy holds in the future — how much inflation there will be, for example, and how healthy growth will be over the years ahead — all embodied in the price of money today, tomorrow and many years from now.
When the yield curve flattens, it is a sign that investors expect mediocre growth in the years ahead.
I think all that is happening in the macroeconomy with the Brexit and other countries in dangerous economic condition is drastically underserved by the little uptick in short-term T-Bills. So I went ahead and looked at the situation from a global perspective.
Several of Europe’s central banks cut key interest rates below zero in 2014, and now Japan has followed. By mid-2016, about 500 million people in a quarter of the world economy were living with rates in the red. Unthinkable before the 2008 financial crisis, the idea is to jolt lending, spur inflation and reinvigorate the economy after other options have been exhausted. By the end of April, about $8 trillion of government bonds worldwide offered yields below zero.
This means that investors holding to maturity will not receive all of their money back. However, if you are uncertain about the fate of the markets, a negative return may in some rare cases still be attractive because it is a relative certainty.
In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good. If banks make more customers pay to hold their money, cash may go under the mattress or into a safe instead, robbing lenders of a crucial source of funding and perhaps even triggering a bank run. Even if that doesn’t happen, there’s mounting concern that when banks absorb the cost of negative rates themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend.
Negative interest rates are an act of desperation, a signal that traditional policy options have proved ineffective and new limits need to be explored. They punish banks that hoard cash instead of extending loans. Europe’s central bank chose to experiment with negative rates before turning to a bond-buying program like those used in the U.S. and Japan. Policy makers in both Europe and Japan are trying to prevent a slide back into deflation, or a spiral of falling prices that could derail the economic recovery.
As with my previous yield curve post, these plots were made in R. I’m always tweaking the code, trying new ways of visualizing it, but soon I will post the code on Github to hopefully get more inspiration from others.