Aug

22

Why in the name of the good one, should bonds be going down on news that the taper will be reduced by 25%. By how much are interest rates affected by an additional 25 billion of liquidity a quarter or so. None of my books on liquidity preference versus expectations seem to think it should be anything like it is. What a tendency to supine submission we mortals have.

Tyler Cowen writes: 

That is exactly my feeling. I have been asking this question for about two months now and nobody has a good answer for me…

It's as if only the current flow matter and the stock of liquid assets somehow fades into irrelevance. Strange.

Rocky Humbert writes:

Excuse me, gentlemen, But can either of you please explain the raisson d'etre for any investor (i.e. someone who buys and holds to maturity) to have purchased a 10 Year TIP at a non-trivial negative real yield — and which has been the case since QE started in earnest.

I submit that your perceptions of befuddlement may be due to price anchoring/recency bias — and that a previous dislocation due to fed interventions is finally being corrected. Investors are now sensibly demanding a positive real return on their fixed income investments. Sensible, unless we are in a persistent deflation. But if a persistent deflation is in the card, the stock market's nominal earnings expectations are horribly wrong.

I further note that bank CD rates are not rising with market rates. To me, this is a potentially ominous conundrum with the following potential explanations: (1) There's little demand for loans. (2) Bank capital rules are limiting their purchase of marketable securities. (3) Banks are funding their loans with overnight excess reserves. (4) Volker rule-type fears are limiting participation. (5) Banks have been told that short-rates won't rise for a really long time.


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  1. Luis on August 23, 2013 1:22 pm

    “None of my books on liquidity preference versus expectations seem to think it should be anything like it is.” Evidence that bonds move for other reasons than the explanations given! I always thought that interest rates move because the cost of money is going up or down. In good economic times I would think that the cost to own dollars will be higher than in times that you can’t even give dollars away at zero interest rates.

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