Why Bond Buying May Work For Now

Negative bond yields may not be a reason to retract. 

Quantitative easing continues to be an agenda of the ECB, even though the past eighteen months of indulgence has resulted in hardly a recovery in the European economies. However, sometime in July this year, the bonds became illegible for purchase when their yields did not increase more than sixty percent. Following the ‘capital key’, Germany contributes the maximum (18 percent) in terms of the extent of bonds that can be purchased from each EU economy. Sensing the decrease in yields, ECB extended its bond-buying program to corporate bonds, earlier this year, in March. Since the yields on the bonds are decreasing, there is little hope of continuing the buying.

With debt being the main culprit behind the 2007-08 financial crisis, little needs to be said about the looming predicaments that economies may face if intuitive policies are not considered. In advanced economies, public sector debt takes a major share, while in emerging economies, there is a dramatic increase in private sector debt. Much of the research on the crisis focuses on government bond yields, as these financial instruments reflect interaction between macroeconomic variables, in an international scenario. Change in yields can be caused by several factors, change in fiscal and monetary policies being one of them. Expectations about inflation, and prevailing interest rates effect bond yields from time to time. The most recent interactive variable has been Brexit.

Britain’s exit from the EU was predicted to send strong jolts to the EU and investors within. Counterintuitively, EU’s missed inflation targets, an unchanged stimulus, and prevailing negative interest rates have all raised concerns over ECB’s plan of action over the next few months. Investor sentiment regarding these policy changes (or otherwise) has markedly contributed to bond yield dynamics. While negative yields are the scenario, it is also true that bonds and bond funds have become an alternative source of investment, owing to the currently prevailing negative interest rates. Lower yields generally mean higher bond prices. It is possible that rising prices of bonds, owing to sale of such bonds could stabilise the market, and bring back normal yields. The ECB is buying corporate bonds, in order to induce this set of factors in the market and therefore increase spending, in order to reach the target inflation level and restart the economy.

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