Saturday, 20 December 2008

ZIRP: Welcome to the world of sub-zero returns

ZIRP: Welcome to the world of sub-zero returns
Zero is a hard number to understand. In multiplication, it turns other values to nought. In division, it turns them to infinity. In finance, it turns the world upside down. No wonder investors are dizzy.

By Edward Hadas, breakingviews.comLast Updated: 12:50PM GMT 18 Dec 2008
The US is repeating a Japanese experiment with a zero in one of the most important variables in financial markets: the official overnight interest rate. This "Zirp" (zero interest rate policy) is combined with a nearly infinite quantity of government borrowing. The US government is expected to stimulate the economy - well into what looks like a bad recession - with as much as $850bn of new debt.
Meanwhile, the recession is inspiring a flight to safety. That means buying government bonds. The 2.2pc yield on the 10-year US Treasury could approach zero if the Federal Reserve follows up on hints that it will start buying Treasuries itself. So bond prices could move higher. But in the currency market, mega-debts and mini-yields are harmful, which is why the dollar has fallen back from Y98 to Y88 in a month.
The combination of falling yields and falling currency is illogical for a country that depends heavily on foreign capital. But in the Zirp world, many things don't quite stack up. The US isn't the only country that offers this investment conundrum. Take the UK, which is similarly indebted, and similarly borrowing more. The country is heading quickly towards Zirp, with the overnight rate of 2pc likely to be cut in half in January. The 10-year gilt yields a low 3.2pc. And the pound has tumbled as fast as the dollar, from E1.18 to E1.08 in a month.
The move towards Zirp is widespread. Japan never really left, and the eurozone is gradually getting there. The thinking is that free money will keep the credit system from freezing up, while higher government deficits should keep demand from collapsing.
But the policies aren't obviously working. The best that can be said so far is that the world could be in even worse shape without them. As no plausible alternatives are on offer, investors should expect more Zirp.
And that points to many sub-zero returns.

Comment: ZIRP = Zero reward to creditors

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