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From Japan to the US to Germany, we are currently seeing longer term bond yields falling at an alarming rate.

I tune into a fair bit of economic commentary, and can often come to some sort of understanding of the factors that commentators say are at play in the current situation. But one I struggle with is the idea that weak private investment is a factor in declining yields.

Can somebody please explain why this is the case? Is the idea that weak private investment leads to weaker GDP growth, which leads to weaker inflation, which leads to higher bond prices? Or is there something else at play here?

Giskard
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Ryan Walter
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2 Answers2

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I think you've answered your own question. Not only would lower inflation be a factor in lower bond yields but also consider that a lower level of demand for loanable funds for private real investment means lower corporate bond yields. That view is cited in the following Larry Summers quote taken from this economics.stackexchange.com question on secular stagnation...

Think about what the world was like when General Motors or AT&T or Exxon or IBM were iconic companies. They were issuing debt. They were investing on a massive scale to expand capacity and to build networks. Now think about iconic companies of today like Apple and Google. They have more cash flow, fundamentally, than they know what to do with. And the result of that, of course, is an excess supply of savings. Another way to approach the question is to say, what's happened to the relative price of durable equipment, either producer equipment or consumer equipment, appliances? And the answer is those prices have gone way down. Well, when those prices go way down it means a given unit of savings goes much further.

All of that, it seems to me, operates to reduce real interest rates

H2ONaCl
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  • So in a nut shell; because there isn't much demand for private investment, investors are buying long term bonds instead? – Ryan Walter Aug 24 '19 at 12:57
  • Financial investors usually just want to make money. Financial investors are buying long term bonds from real asset investors. In the current environment real asset investors sell bonds and many have been using the money raised to buy their own shares or increase their dividend if they do not see the need to increase real asset investment. – H2ONaCl Aug 27 '19 at 20:20
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First, when yields go down, prices go up and vice versa, simply because of how bonds are valued... I.e. lower yields $\iff$ higher prices $\iff$ higher debt demand ceteris paribus.

When the yield curve inverts, it simply means that investments are going to long term "projects" (and so do the demands for bonds) rather than to short term ones. Put differently, it shows what investors think of "tomorrow" versus "after-tomorrow". And in the case we are interested in, they think that short term (ST) investments are either less profitable or more risky than long term ones $\rightarrow$ the demands concentrate on long term bonds $\rightarrow$ their price increase. In the meanwhile, this means less ST investments, which means a weaker growth-engine (production-based) over the ST, which means an unemployment rate augmentation, which means less consumption, which means less inflation, which means less (per sector) profitable short and mid term perspectives, and so on.

So, what is especially missing in your understanding is the mutually-exclusive nature of the directions of debt demands for different time horizons.

keepAlive
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  • Okay that is easy enough to understand. So you are saying that in this case, 'private investment' is referring to the fact that companies/investors are buying long term bonds rather than short term bonds? Not that companies are buying long term bonds rather than investing in projects designed to boost productivity? – Ryan Walter Aug 24 '19 at 12:54
  • @Ryan first, the "private" nature of these investments adds no explanatory power to the answer your are looking for. Second, the sentence "[...] is the idea that weak (private) investment is a factor in declining yields" is simply incomplete. The complete version (but still not really healthy conceptually speaking) is "[...] is the idea that weak (private) investment *in ST-horizon debt* is a factor in declining *LT-horizon* yields". – keepAlive Aug 24 '19 at 13:28
  • @RyanWalter To be even more complete : "companies are buying long term bonds *designed to boost productivity over the long-run* rather than investing in projects *designed to boost productivity in the short term". And something that you may also want to grasp is that, actually, "buying bonds" is considered to intrinsically* boost productivity in economic theory, i.e. investments are always assumed to boost productivity in economic theory. The question is: are these investments being made tomorrow or after-tomorrow(?) If it is after-tomorrow, then it is at the expense of tomorrow. – keepAlive Aug 24 '19 at 18:43
  • This thread is impossible to read: "companies" can be real asset investors selling bonds to buy production assets or financial investors buying those bonds from the former. If you say inversion means "companies are buying long term bonds" you are talking about financial companies, but usually financial companies don't have strong designs on productivity. Many of them don't care as long as they make money in the short or medium term. It is usually real asset investors that manage productivity decisions but they are selling bonds; the stock of outstanding bonds has increased in recent years. – H2ONaCl Aug 25 '19 at 20:46
  • @H2ONaCl indeed companies can be many things ;) That being said, commentaries are not made for discussions. If you have any question, please do not hesitate to create one. – keepAlive Aug 25 '19 at 21:07
  • I'm just pointing out that the companies that make productivity enhancing investments have in recent years been increasing bond debt outstanding. They are selling bonds whereas you are saying the opposite. – H2ONaCl Aug 26 '19 at 07:25
  • Any question @RyanWalter ? – keepAlive Oct 17 '19 at 11:30