Typography

Here's a conundrum. Many commentators have been trying to puzzle out why stocks have been continually hitting new highs at the same time that bond yields have been hitting new lows. See here , here , here , and here . On the surface, equity markets and bond markets seem to be saying two different things about the future. Stronger equities indicate a bright future while rising bond prices (and falling yields) portend a bleak one. Since these two predictions can't both be right, either the bond market or the stock market is terribly wrong. It's the I'm with stupid theory of the bond and equity bull markets. I hope to show in this post that investor stupidity isn't the only way to explain today's concurrent bull market pattern. Improvements in financial market liquidity and declining expectations surrounding the pace of consumer price inflation can both account for why stocks and equities are moving higher together. More on these two factors later. 1. I'm with...

The zero-lower bound is the well-known 0% floor that a note-issuing bank hits whenever it attempts to reduce the interest rate it offers on deposits into negative territory. Should the bank drop rates below zero, every single negative yielding deposit issued by the bank will be converted into 0% yielding notes. When this happens, the bank will have lost any ability it once had to vary its lending rate. The ZLB is an artificial construct. It arises from the way the banking system structures the liabilities that it issues, namely cash and deposits. We can modify this structure to either remove the ZLB or find alternative ways to get around it. Much of the discussion over the econblogosphere over the last few years has been oriented around various ways to get below zero. There is another artificial bound, this one to the upside—let's call it the 5% upper bound, or FUB. The FUB is an archaic bound. Up until 1854, the Usury Laws prevented the Bank of England from increasing rates above...

Real t-bill and bond yields have been falling for decades and are incredibly low right now, even negative (see chart below). With an eye to historical real returns of 2%, folks like Martin Feldstein think that bonds are currently mis-priced and warn that a bond bubble is ready to burst. Investors need to be careful about comparing real interest rates over different time periods. Today's bond is a sleek electronic entry that trades at lightning speed. Your grandfather's bond was a clunky piece of paper transferred by foot. It's very possible that a modern bond doesn't need to provide investors with the same 2% real coupon that it provided in times past because it provides a compensating return in the form of a higher liquidity yield. [By now, faithful readers of this blog will know that I'm just repeating the same argument I made about equity yields .] Here's a way to think about a bond's liquidity yield. Bonds are not merely impassive stores-of-value, they ...

The discussion on own-rates, the natural rate, and Sraffa cropped again. Andrew Lainton blogged here , followed by Nick Rowe here , Daniel Kuehn here , and David Glasner here . It seems to me that Nick and David are more or less on the same side of the aisle. I commented on Nick's post here , and Nick provided a helpful response. I commented on Glasner here , and he gave me some good feedback.

David Glasner noticed a very interesting anomaly yesterday. In short, 5-year TIPS rates seem to be rising while 10-year TIPS have been falling. He encouraged his readers to do some investigating to find out why. See my findings below. Rather than using the constant-maturity TIPS yields as my starting point (which come with 5, 7, 10, 20, and 30 terms) I looked at actual TIPS yields. I was interested to learn that constant-maturity yields are not market yields. Rather, they are derived from a statistical method that smooths actual yields in order to compute a surrogate constant yield. Constant yields are useful because they provide continuity, but it is easy to forget that the market yields are the true parent data series upon which they are based. Below is a chart showing market 10-year TIPS yields for various TIPS vintages since 2006. click chart to zoom What is evident is that anomalies have happened before. While 10-year TIPS yields in general follow each other in the same direction...

Econbrowser has a post on inflation expectations as measured via TIPS spreads. This links back to an earlier comment I made on Glasner's blog , in which inflation swaps are posited as an alternative to TIPS spreads. Here is the comment from Econbrowser: "One might worry about characteristics in the TIPS market distorting the estimates of the real yields."  and  "The real yield curve starts at five years, so one can’t be sure what the real yield curve suggests for the horizon less than five years. "  Why not use zero coupon inflation swap prices? They (supposedly) don't suffer from some of the same distortions as TIPS (liquidity premia), and you can get shorter terms.  For instance, here is the 2 year inflation swap.  http://www.bloomberg.com/apps/quote?ticker=USSWIT2:IND Just subtract the 2 year swap rate from the nominal 2 year rate and you have the 2 year real rate.  See the Cleveland Fed's explanation of their methodology for measuring inflation exp...