Wednesday, October 27, 2010

And now, negative yield bonds!

Conventional economics teaches us that loans come at a cost. In an inversion of this universal reality, an interesting auction of five-year US Treasury Bonds has resulted in investors paying $105.50 to buy $100 bonds, thereby "agreeing to pay the government for the privilege of lending it money".

These bonds, Treasury Inflation Protected Securities (TIPS), attracted investors since they offer a guaranteed protection against inflation. Though TIPS have been yielding negative yields for some time now, it is the first time since the government began selling these them in the 1990s that new ones were sold at a negative yield.

These bonds will have the same final payout, irrespective of the inflation, and in the meantime their prices will increase if inflation soars. In simple terms, "the investors who took part in the $10 billion auction are betting that inflation, now at about 1% annually, will rise to a level that more than compensates for the premium they paid". In an indication of the investor interest, the $10 bn auction attracted $28 billion worth of bids.

This negative yields for five-year TIPS, reflect the investors hope, in the light of expectations of a second round of quantitative easing in the US, that the Fed will succeed in generating inflation, thereby making their investments remunerative. Though, deflation is the short-term trend, they hope that in the medium-term, as the economy starts recovering, inflationary pressures will get unleashed.

1 comment:

Sai Prasad said...

Be good to have such products here in India. Do we have them ?