The sky is falling! Or, well… bond yields are at any rate. Germany recently issued some 5-year notes at a negative yield, and several other European countries have bonds whose yields are currently negative. See here for some good discussion on why and what it means for financial markets. One very interesting point was made close to the end of the article I linked to: that bond funds (mutual funds that only or largely invest in bonds) will keep buying whatever bonds are available because of the idle cash they have. Legally, at least in the U.S. and Canada, a mutual fund has to abide by the investment style written down in its prospectus, and that includes a maximum amount of cash they can hold. So a fund can’t either (a) return the money or (b) leave it idle, even though 0% nominal returns on a checking account are better than <0% returns on a bond.

Briefly, bond yields are a function of the bond’s promised interest payments to the holders of the bond, known as coupons; the par value of the bond, which is the amount the holder receives when the bond matures; the tenor of the bond, or the time to maturity; and the current market price of the bond. Price and yield are inversely related, so to get a negative yield, the bond price has to climb above a certain threshold value. That threshold value is simply the some of the (non-discounted) coupons, and the par value.

Now, I’m given to understand funds are buying these bonds because they are making a capital gains play. Okay, that’s one way to score some positive returns on a negative-yielding bond, and probably beats holding the bond until maturity and locking in that negative return. But the only way to get a capital gain here is for yields to go even lower. There is some suggestion this can happen, as the ECB has instituted an “expanded asset purchase programme” since January 22nd, 2015. But it remains to be seen how good of a play this continues to be as time marches on.

Negative bond yields have implications, not well understood at this time, for macroeconomics and monetary policy. Just Google “zero lower bound” and you’ll get a stack of results. Paul Krugman, for example, has ridden the ZLB concept hard as a reason for activist fiscal policy, since monetary policy stops working at the ZLB. Why? Because rates can’t go lower than zero! But of course, as we now see, they can. This also has implications for financial economics, as most of the models we use to describe interest rates and their evolution are specified so as to prevent interest rates from crossing into negative territory.

I will make one prediction right now: pursuit of ultra-low interest rates will do nothing to spur growth anywhere. Growth will come from reducing real barriers to investment and hiring and entrepreneurial activity.