Trends: Long-Term Liquidity In Relation To Interest Rates

Quantitative Easing, Interest Rates & Liquidity:
Studies show negative a correlation between reserves and long-term yields at a zero lower bound. The market saw a decrease in returns on 10-year US Treasury Bonds post financial crisis that was not seen in public Treasury Bonds. There is an expectation of a positive correlation between an increased money supply and short-term interest rates known as the liquidity effect. When short-term interest rates reach the zero lower bound (ZLB), the liquidity effect disappears because the short-term interest rates form a substitute for the money supply at the zero interest rate. Because investors will tend to seek higher returns, a higher demand is created leading to a reduction in yield. Increased reserves at the zero lower bound should be correlated to lower long-term yields.

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