, , , , , , , ,

EVERY time commentators say that bond yields cannot go any lower, the markets take delight in proving them wrong. After Britain’s shock decision to leave the European Union, yields dropped again: the income on ten-year Treasury bonds reached a record low, and German and Japanese yields headed further into negative territory (see chart). The prospect that monetary policy would remain accommodating also helped shares on Wall Street reach new highs.

Interest rates are the oil in the financial system’s engine, helping capital to flow from one area to another. There is a reason that rates have been positive for the past three centuries, despite world wars and the Depression. The system isn’t designed for a world of ultra-low, let alone negative, rates.

The traditional business of banking is to take money from depositors (a bank’s liabilities) and lend it, at higher rates and over longer periods, to borrowers (its assets). So an important driver of profits is the shape of the “yield curve”—the chart of interest rates for different durations. The smaller the gap between short- and long-term rates (the flatter the…Continue reading

First published here: http://j.mp/2a15LM6