Negative interest rates take investors into surreal territory

[Spekulatius]

The central providers are fond of warning us about $1.3 trillion in leveraged loans.

 

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

 

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

[Cigarbutt]

^Whether one is expecting a greater fool or forced by a central authority, it seems that this is fertile ground for an imbalance.

https://gallery.mailchimp.com/7372687636bfa669f0a51ec26/files/3ee5faf6-38fe-412b-9305-83fcbc417eb2/2019_07_04_Betting_Against_The_Gods_Is_Now_Impossible_Charles_Gave.pdf

 

With the recent ECB nomination and the expected push for more easing and further dive into negative territory, it looks like Europe is following Japan in its path.

https://www.inflation.eu/inflation-rates/japan/historic-inflation/cpi-inflation-japan.aspx

 

A few days ago, the BIS released their half-year report:

https://www.bis.org/publ/arpdf/ar2019e1.htm

It's long and boring but I think the take-away message is the following:

"The room for policy manoeuvre to address these risks has narrowed since the Great Financial Crisis (GFC) of 2007-09, and regaining it has proved harder than originally thought. One example is monetary policy. After shoring up the economy during the GFC, with other policies taking a back seat, central banks were instrumental in supporting the subsequent recovery. While central banks succeeded, an inflation rate stubbornly below objectives even with economies seemingly operating close to potential has made it harder to proceed along the normalisation path. In addition, after the prolonged period of plentiful accommodation, financial markets have proved very sensitive to signs of policy tightening while some financial vulnerabilities have emerged. As a result, intertemporal trade-offs have come to the fore. The continuation of easy monetary conditions can support the economy, but make normalisation more difficult, in particular through the impact on debt and the financial system. The narrow normalisation path has become narrower."

Isn't value investing about intertemporal trade-offs?

 

 

[John Hjorth]

^Whether one is expecting a greater fool or forced by a central authority, it seems that this is fertile ground for an imbalance. ...

 

I think the same way as you do, Cigarbutt,

 

Short/medium term, perhaps this starts as a large liquidity event, also ref. Spekulatius.

 

Here is a piece, that covers my state of mind recently, related to this phenomena : Scott Galloway : "Earth vs. the Universe".

 

[Not that is helps much, though. Watering my roses etc. doesn't help either. Nor does mowing the lawn - despite that, it's on the to do list for this afternoon.]

[Jurgis]

The central providers are fond of warning us about $1.3 trillion in leveraged loans.

 

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

 

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

 

"when everyone runs for the exit" for negative interest rate loans is no different from "when everyone runs for the exit" for the positive interest rate loans.

 

Also if rates go up, it doesn't matter whether the bond you held was at -1% and rate went to 1% or if it was at 1% and rate went to 3%. You gonna have comparable losses (well, the math is more complicated for detail obsessed, but you get the drift).

 

Also if negative rate loan is discounted enough, it turns into a positive rate loan on YTM.

[SharperDingaan]

You might want to step back and look at this a little differently ......

 

What is the practical limit to monetary policy?

Most would argue when sovereign debt (no credit risk) trades at a 0% YTM - simply because 'they', have to pay 'you' to hold their bond.

But in Europe, there are multiple sovereigns within the EU, of different credit quality; and none of those sovereigns will get to 0%, because we will cut the price of each sovereigns bond first (ie: Greek vs German bond). So ... track the the price difference on benchmark Greek vs German sovereign bonds, and look for when it sudddenly starts widening.

 

Why is there no fiscal policy response?

We know that borrowed money can be either helicoptered into circulation (monetary policy), or spent on public works. Yet apparently there is no infrastructure (around the world) worthy of rebuilding?, and no insurance/pension funds (around the world) looking to earn more on the fixed income portfolios - than that currently available on sovereign debt?

 

Because if we think there are projects, this lack of a fiscal response must be because the monetary to fiscal policy transfer mechanisms are either frozen(CB's), or broken. If they are not working, why not?

 

We would suggest CB capture .... and that it can be exploited.

 

SD

 

 

 

[mcliu]

The central providers are fond of warning us about $1.3 trillion in leveraged loans.

 

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

 

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

 

Can negative-rate loans default? Wouldn't the company just refinance at even lower rates? Maybe even negative-coupons?

 

It's clear that monetary policy is reaching is limits in effectiveness. Rates are below zero without significant effect on economic growth and inflation.

 

SD makes a good point, it is interesting that there's been such a lack of fiscal response..

[Spekulatius]

^ Negative loans still have amortization as main cash expense for the  borrower, so default is possible.

[John Hjorth]

Or some existing bonds may have run up above face value, so there may still be a positive nominal interest rate on them, that has to be paid. Example : Danish State bonds. [There aren't many in circulation though - some DKK 500 M, because Denmark does not run at a deficit].

 

- - - o 0 o - - -

 

Some bond investors have made serious money in this environment - till now.

[mcliu]

^ Negative loans still have amortization as main cash expense for the  borrower, so default is possible.

 

Yes but if a borrower needs cash to pay for their principal amortization, can't they can just borrow more? And if they need more cash to repay those debts (interest/principal), they can borrow even more.. so on and so forth.. Doesn't that make default impossible. Hence, the term zombie firms?

 

So in order to default, you would need a liquidity crunch.. However, central banks are suggesting that if you want to borrow, they will lend. So they are effectively guaranteeing liquidity.

 

[JimBowerman]

 

With the recent ECB nomination and the expected push for more easing and further dive into negative territory, it looks like Europe is following Japan in its path.

https://www.inflation.eu/inflation-rates/japan/historic-inflation/cpi-inflation-japan.aspx

 

 

imo Europe (and Japan to a greater extent) hasn't changed the 2050 supply of MB, they've just front loaded the money printing which leads to bloated central bank balance sheets but persistently low inflation.  The market has sniffed this out, called the central banks bluff and,the markets have won.

 

I don't see any long term change in ECB policy and short a drastic change in politics, don't see inflation rising.

 

Far from an "expected push for more easing", when you look at the anemic NGDP growth in Japan and EU, you see that monetary policy has instead been overly restrictive and tight - and likely to remain so in the future.

 

Japan stating their target for the JGB is 0% only tightens monetary policy further...the exact opposite of what the bank of Japan wants.

 

Should note that unhelpful comments from the U.S. regarding the almost useless term of "currency manipulation" also makes any sort of needed devaluation in Japan and EU very unlikely in my opinion.  The market knows all this

[RuleNumberOne]

Charles Gave is the new Warren Buffett, he tells you everything you need to know about negative rates. Cigarbutt's "mailchimp" link held this treasure from Charles Gave:

 

"One day he was called by a

pension regulator at the central bank and reminded of a rule that says funds

should not hold too much cash because it’s risky; they should instead buy

more long-dated bonds. His retort was that most eurozone long bonds had

negative yields and so he was sure to lose money. “It doesn’t matter,” came the

regulator’s reply: “A rule is a rule, and you must apply it.”

 

Back in May 2016, an institutional investor bought a five-year zero coupon

bund at €103. Five years on, the bond will be repaid at €100, generating a loss

of €3. How this loss appears will depend on the type of investor in question:

• Pension fund. The €3 loss will reduce the market value of assets by €3.

Holland also has a rule that pension funds must buy more government

bonds the closer they get to being underfunded. Yet buying such

negative-yielding bonds and keeping them to maturity ensures losses,

making it more likely the fund will be underfunded, and so forced to buy

more loss-making bonds (spot the feedback loop)

 

Bank. As a leveraged player, let’s assume it lends a fairly standard 12

times its capital. This capital has to be invested in “riskless” assets that

are always liquid. As a result, banks are loaded up with bonds issued by the

local state. Now let us assume that a bank has just lost €3 on the zerocoupon bond mentioned above. The bank’s capital base will be reduced by

€3. Based on the 12x banking multiplier, the bank will have to reduce its

loans by a whopping €36 to keep its leverage ratio at 12.

 

Insurance company.  A standard solution is to cover the

maximum amount of risk with a government bond of similar duration to

the client’s contract period, and then put the remainder into equities or

real estate to help build up the firm’s capital base.

This gets very difficult when government bonds offer negative yields.

Simply put, either the insurance company’s

clients will pay the negative rates, or the company itself will do so by

increasing its risks without raising returns. This means that either the

client pays more for insurance, and so becomes less profitable, or the

insurance company takes a hit to its bottom line."

[RuleNumberOne]

Fiscal policy is impossible: German taxpayers are not going to pay Greek pensions.

 

Draghi has to keep the treadmill (aka bond market momentum aka negative yields) going faster. The faster it goes the harder the crash when momentum reverses. The ECB is made up of charlatans who have blown a big fraudulent bubble.

 

The US quickly cleaned up the bad bank assets, liquidated many large banks, strengthened the capital base of remaining banks, all this to get them lending.

 

The European Charlatan Bank has done the reverse: cover up fraudulent accounting and bad assets, bailout everything in sight, erode banking capital base with negative rates and forced bond purchases.

 

They are still in trouble, no change in debt to GDP in troubled countries, just more debt and a housing bubble in Germany, Netherlands, etc.

[John Hjorth]

...The European Charlatan Bank has done the reverse: cover up fraudulent accounting and bad assets, bailout everything in sight, erode banking capital base with negative rates and forced bond purchases. ...

 

It's beyond my comprehension, that you continue this line of posting here on CoBF, RuleNumberOne. You are just back in "your old plow furrow" with rambling name-calling & undocumented claims, while simultaneously, you have already exposed your ignorance with regard to European banks and their regulation.

[SharperDingaan]

"Fiscal policy is impossible: German taxpayers are not going to pay Greek pensions. "

 

This is an example of CB capture ...

Germans paying greek pensions executes as monetary policy, not fiscal policy.

Were it to execute as fiscal policy; Germans would fund the build and lease-back of greek airports/seaports/toll highways/etc - collect the annual lease payments, and let Greek workers pay into their pension plans. Germans would receive real (state-of-the-art, & earning) assets as collateral, as well as a reduction in the Greek pension fund liability (Greek workers paid some more $ in). And all in addition to less Greek default risk, as better Greek infrastructure facilities increases tourism and related cashflow. Yet, despite lots of very smart people in both Germany, and Greece - this just doesn't happen?

 

Our own thoughts are that it doesn't happen in a Germany, because there are aren't enough trades workers.

Fiscal policy would cause wage and CPI inflation, but the resultant rise in interest rates would cause asset deflation - and the value of risk weighted banking assets to collapse. Fewer banks, lots of unemployable workers (not trades) on the streets, and most of the 'trades' new wealth being remitted home versus kept in the country. Not great for social stability either.

 

Instead, we get interesting times.

 

SD

 

 

 

[SHDL]

The central providers are fond of warning us about $1.3 trillion in leveraged loans.

 

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

 

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

 

This was in the news yesterday:

 

https://www.bloomberg.com/news/articles/2019-07-16/a-leveraged-loan-collapses-and-reveals-key-risk-in-credit-market

 

It's an obscure story that has not been widely reported, but probably worth noting because this is how these things tend to start.

[SHDL]

Also, see this for some general background on CLOs:

 

https://www.bloomberg.com/opinion/articles/2019-03-03/collateralized-loan-obligations-are-riskier-than-most-realize

 

I must say, this looks pretty bad...

[RuleNumberOne]

We need just a 1% increase in yields for $2.4 trillion in sovereign-debt losses because investors have been forced (some of them by regulators) to swallow long-bonds at zero/negative rates (Austria 100-year at 1%, Swiss 2064 expiry at 0%, and so on). Greece 10-year yields less than US 10-year!!! So far, its been a great ride as bond prices go past the stratosphere.

 

https://www.bloomberg.com/news/articles/2019-06-26/trillion-dollar-monster-lurks-as-bonds-price-out-duration-risk

 

"But just look at the math. The Macaulay duration on a Bloomberg Barclays sovereign-debt index is near a record high of 8.32 years, meaning just a one-percentage-point increase in yields would equate to more than a $2.4 trillion loss.

 

One measure of the relative compensation investors receive to hold longer-dated obligations is a whisker away from a 58-year low. Over in Europe, they’re taking a century of risk for yields barely above 1% in order to escape a $13 trillion global stockpile of negative debt.

 

All that is leaving duration, a measure of sensitivity to interest-rate changes, near all-time highs across sovereign debt markets.

 

One gauge of the compensation investors demand to hold longer-term Treasuries versus rolling over short-dated obligations, known as the term premium, is near record lows -- underscoring the intense conviction in the low-rate, lowflation era in markets. Over in Europe, the ask yield on Swiss bonds due 2064 even fell below zero percent last week."

 

 

The central providers are fond of warning us about $1.3 trillion in leveraged loans.

 

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

 

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

 

Can negative-rate loans default? Wouldn't the company just refinance at even lower rates? Maybe even negative-coupons?

 

It's clear that monetary policy is reaching is limits in effectiveness. Rates are below zero without significant effect on economic growth and inflation.

 

SD makes a good point, it is interesting that there's been such a lack of fiscal response..

[Cardboard]

Dalio says to buy gold:

 

https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html

 

Eventually it seems that hard assets become the place to be to protect one from devaluation, default and what you are mentioning RuleNumberOne.

 

And on top of that, these areas have been abandonned for many years with little capital investment. Certainly the case for the entire commodity complex.

 

Cardboard

[John Hjorth]

Dalio says to buy gold:

 

https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html

 

Eventually it seems that hard assets become the place to be to protect one from devaluation, default and what you are mentioning RuleNumberOne.

 

And on top of that, these areas have been abandonned for many years with little capital investment. Certainly the case for the entire commodity complex.

 

Cardboard

 

What is it, that you're really suggesting here, Cardboard?

[SHDL]

Also, see this for some general background on CLOs:

 

https://www.bloomberg.com/opinion/articles/2019-03-03/collateralized-loan-obligations-are-riskier-than-most-realize

 

I must say, this looks pretty bad...

 

I got this report in the mail:

 

https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2019/july-2019.pdf

 

There is some data and discussion starting on p. 24 on who owns these loans (directly or through CLOs).  Apparently banks own a big chunk of this, which I don’t like.

[Cigarbutt]

Dalio says to buy gold:

 

https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html

 

Eventually it seems that hard assets become the place to be to protect one from devaluation, default and what you are mentioning RuleNumberOne.

 

And on top of that, these areas have been abandonned for many years with little capital investment. Certainly the case for the entire commodity complex.

 

Cardboard

 

What is it, that you're really suggesting here, Cardboard?

I guess part of the answer is expectations related to mean reversion.

https://www.marketwatch.com/story/this-chart-from-gundlachs-doubleline-capital-says-commodities-are-due-to-rally-2018-01-31

Mr. Gundlach who is now financially related to both Mr. Marks and Mr. Flatt has expressed, for some time, that the interest rate 'environment' has contributed to the relative valuation profile and the generational occurrence of the present situation.

 

What is Mr. Gundlach's opinion about negative interest rates: negative, very negative.  :)

Disclosure: I've held (indirectly) physical gold from 2003 to 2008 and, despite the outcome, decided that the process was wrong and promised never to do it again. I guess, renewed interest in gold (Dalio et al) may have something to do with potential currency debasement.

 

[RuleNumberOne]

 

Buffett on negative rates in the video above:

 

- "distorts everything"

- "we do not know how this movie plays out"

 

That video was over 3 years ago.

[RuleNumberOne]

European Project continues at warp speed as Italian bank sells 7-year collateralized bond at 0.44% yield. Investors from Germany and Austria accounted for more than a third of the allocated orders.

https://www.ft.com/content/c54a4dcc-a892-11e9-984c-fac8325aaa04

 

 

Former Bundesbank chief (and former ECB "Governing Council" member) Axel Weber is saying in a different way what Munger said about paying A+B for what ends up as A at the end of the day.

 

https://www.bloomberg.com/news/articles/2019-07-17/europe-dived-into-negative-rates-and-now-it-can-t-find-a-way-out

“I would never say you cannot go negative, you can do everything for a short time,’’ Axel Weber, chairman of UBS and a former ECB policy maker, said in Zurich this month. “But it’s like diving into water. You can stay under water for some time, you can’t stay there forever.’’

 

[John Hjorth]

Finans.dk [July 31^st 2019] : Here business customers avoid paying negative interest rates - and here they pay at cash register one.

[RuleNumberOne]

FT finally saying what i said earlier: the article advises people to put money in Swiss vaults rather than Swiss banks.

 

No one wins in the rabbit-hole world of negative interest rates

https://www.ft.com/content/8081ff4c-b52f-11e9-bec9-fdcab53d6959

 

"Mr Hamers has a point. Rather than encouraging people to borrow and spend, the data suggests nervous eurozone consumers are hoarding. Eurostat reports the eurozone household savings ratio is at a five-year high of nearly 13 per cent.

 

A similar but more dramatic phenomenon seems to be in evidence among the big wealth managers.

 

One reason why UBS and CS are planning to pass on negative rates is that wealthy clients’ obsession with cash has become such a large problem for them. UBS reckons 26 per cent of its clients’ assets are held in cash. At CS, the proportion is 29 per cent."

 

The tolerance for pain and stupidity is very high in the 'Eurozone'. Germany and Italy GDP figures have been hovering between -0.1% to 0.1% for the last 1.5 years.