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Econbrowser‘s James Hamilton discusses Negative real interest rates:

In terms of the Fed’s policy objectives at the moment, one of the problems with deflation is that it guarantees a positive real return just from stuffing cash under your mattress. A primary purpose of the Fed’s contemplated QE2 is to prevent this and spur consumers and firms to invest funds productively rather than hoard cash. Insofar as the recent moves in TIPS and other yields represent the market already pricing in the Fed’s next steps, one might conclude from the latest TIPS readings that this aspect of the Fed’s strategy is already working.

He attaches a good graph:

Click for Big

Although this appears to be the first time that newly issued TIPS have locked in a negative real return, that’s because TIPS have only been offered to U.S. investors since 1997. You can get a longer time series by comparing the yield on a 6-month T-bill at any date with what the CPI inflation rate actually turned out to be over the subsequent 6 months for which investors held that bill, a magnitude sometimes described as the “ex-post real interest rate.” That series is plotted below. We’ve actually been in a period for several years in which short-term loans to the government were a losing proposition in real terms, and the longer-term real yields such as the 5-year TIPS are only now coming down to join them. The recent era of negative real yields was briefly (if spectacularly) interrupted in the fall of 2008, when a sharp deflation in the CPI made short-term loans to the government an excellent deal for the lender in ex-post real terms.

The Canadian preferred share market continued its recent (boring) pattern with a good day on elevated, if somewhat lower than recent norms, volume. PerpetualDiscounts gained 10bp and FixedResets squeaked out a win of 2bp. It should be noted that, given about 250 trading days in a year, a daily win of just over 1bp is expected.

This entry was posted on Thursday, October 28th, 2010 at 8:51 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.