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Investors are expecting a lot of deflation

Posted by: Aaron Pressman on December 9, 2008

The U.S. Treasury completed a remarkable auction of four-week Treasury bills today. No surprise that there was a ton of demand for the only investment still viewed as a safe haven — there were bids worth $120 billion for the $30 billion of bills being sold. But how low did bidders go on the yield they’d accept to own the bills? All the way down to zero. That’s right, the U.S. government just borrowed $30 billion at a cost of zero percent interest. That follows yesterday’s auction of 3-month T-bills at the microscopic rate of 0.005%, the lowest since the long-running 3-month maturity first hit the market in 1929.

According to a Bloomberg report on the bond market today, the 3-month bills are now trading at a negative yield, meaning buyers get a guaranteed loss, albeit a small one. One trader cited by Bloomberg noted that companies are eager, even desperate, to show they hold only ultra-safe T-bills on their balance sheets for fourth quarter earnings reports so they’re willing to accept the negative or zero yields.

That’s an awfully high price to pay for sleeping soundly at night, but if you have more money than can be easily kept under bank insurance deposit limits, there aren’t many alternatives. And it implies that investors are so worried about the safety and possible decline in value of most investments that they’re willing to lend merely on the assurance of getting their principal back intact. While some analysts fear runaway inflation from all the government bailouts and borrowing, the T-bill market at least is giving a pretty clear signal that’s not what is on big investors’ minds. They’re worried about the opposite, widespread deflation from the ongoing credit crisis, like the falling prices that occurred during the Great Depression.

UPDATE: Perhaps not surprisingly, economist Nouriel Roubini, who has been arguing for a coming wave of painful deflation, has jumped all over the latest T-bill results. He says the situation is developing into a “liquidity trap.” Because investors get paid no more to hold bonds than cash, they become further reluctant to lend. That makes it harder for the government to stimulate the economy through fiscal policy (such as lower interest rates), he says:

The consequence of falling prices (i.e. the prime reason why nominal interest rates should be that low) is that the real value of nominal liabilities will rise as do real interest rates once the nominal interest rate hits the zero bound. The incentive towards hoarding cash and saving instead of investing is thus self-reinforcing as the deflationary spiral takes hold. Any increase in money supply (like quantitative easing) goes into servicing higher real debt levels—> breaking a deflationary spiral therefore requires fiscal stimulus or balance sheet restructuring or both.

The web post has a bunch of useful links for background on the subject, as well.

There’s also a downside for the little guy when T-bill rates get this low. A handful of fund firms like JP Morgan and Evergreen have even closed their money market funds to new investors because if the funds got more deposits they’d have to buy more T-bills in the current tight market. That would depress the funds’ yields for everybody already invested. It’s an unheard and almost unimaginable situation.

Reader Comments


December 9, 2008 5:44 PM

Zero means safe?


December 9, 2008 6:00 PM

1996-2001: Internet bubble
2000-2006: Housing bubble
2005-2008: Commodity bubble
2008-200?: Treasury debts bubble


December 9, 2008 6:08 PM

No. Zero means desperate.


December 9, 2008 6:42 PM

A Treasury debt bubble would mean increasing returns on the T-bills until a crash in value.

Tom E.

December 9, 2008 7:06 PM

Could be the Fed is trying to force people out of the short term and into longer term debt.

In other words, quit sitting on your money with T-Bills and start doing something with it.

Susan KF

December 9, 2008 7:50 PM

It sounds like you (and Roubini) don't see these funds being moved into other investments when the bills mature. These TARP funds are supposed to be lent. Hard to believe that this won't ease up after the first of the year, one way or another.


December 9, 2008 9:02 PM

The ghost in the room is unproductive consumers who borrow but lack adequate discipline (moral fiber)to repay. It took a lot of effort to destroy social moral fiber question is can it be restored and if so what will it take?


December 9, 2008 9:31 PM

wooooooooooow!well all i gotta do is take notes:)

Navin Kumar

December 9, 2008 11:23 PM

What Treasury needs is "Capital Stimulus" in itself, that when bills mature (hopefully in shorter time) it can yield and move it other investments for lending.


December 10, 2008 1:39 PM

Elvis Costello sang it best: "Everything is less than zero."

Bichael Moskey

December 11, 2008 8:33 PM

"through fiscal policy (such as lower interest rates)"

I believe interest rates are monetary policy, not fiscal policy.

Apart from the difference in strategies employed (i.e. expenditure/taxes vs interest rates). Marrying the two also implies that the federal reserve is not acting independently. Therefore the distinction is important.


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