Feb

17

Back in 2011, I noted how quality corporate bond yields had disconnected from sovereign yields– and was undermining the shibboleth that the "risk free rate" is the sovereign rate.

Today, a related thing is happening that may well create an interesting challenge for both the fed and investors.

It's well known that sovereign yields have gone negative in the Eurozone. The second order effect of this is that corporate bonds of GE, Philip Morris, McDonalds, and other A+ corporates are moving towards negative nominal yields too. For example, short term GE paper in Switzerland (Swiss Franc denominated) is now yielding below zero. Yes — that's right. People are giving GE money with the understanding that they will get back less in the future.

This phenomenon has never been seen before in the annals of capitalism. It begs the question of "What is an investment?" Or perhaps even "what is capitalism?"

If GE can issue debt at a negative nominal yield, what does this mean for the valuation of their equity (which is denominated in US$)?

What does this mean for the Fed model?

There are so many questions here that are not addressed in economics text books. For example, how can equity drift be positive when nominal interest rate drift is negative?

Will the answer will ultimately be found in the currency markets? Is this the essence of a liquidity trap? A roach motel for capital?

anonymous writes: 

Seems like it opens up an opportunity for currency storage. Although the highest denomination US currency is the $100 "benjamin", there exists a 1000 CHF note. I'll estimate that you can store about 200,000 notes in 1 cubic meter. With each note worth 1000 CHF, a 0.1% negative interest rate would earn GE 200,000 CHF per cubic meter of storage. For reference, Manhattan apartments rent for something like $1,000 per square meter. Each square meter in a pre-war building with high ceilings could get you about 3 cubic meters of storage. So GE could rent for $1,000 per square meter and earn 200,000 CHF in negative interest.

anonymous writes: 

Again, from the cheap seats: It seems that we're seeing all sorts of strange things because players are looking for safety with some hope of capital/forex appreciation, so they accept negative yield. And since some of the CBs and other banks are pushing negative yields anyway, what's not to like? But is anybody looking at GE's swissie bonds and thinking that the situation represents some underlying economic reality unmediated by CB action? (That's not a rhetorical question, btw.)

When they actually implemented the €Mark, I was skeptical because I thought, "Either the Italians are going to have to become a lot more like the Germans, or the Germans are going to have to become a lot more like the Italians." Now we are seeing the crucial period of the experiment, when we find out whether they can get through this to the other side. I remain skeptical.

Peter Grieve writes: 

There's the rub. There really is no such thing as Europe, just a recently cobbled-together collection of disparate nations with long histories as separate cultures (indeed, some of those nations are themselves rather recently cobbled together!).


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