Unintended Consequences, Part 3: “How Do I Get Away From Negative Yields?”
by John Rubino
The theory was pretty straightforward: push interest rates down far enough — in some cases to negative territory where borrowers actually turn a profit on their debts — and people will borrow money, spend it, and growth will ensue, with all that that implies for incumbent party election victories, banker year-end bonuses and other extremely important public policy goals.
But the theory’s designers apparently missed some crucial concepts — like the fact that people would be free to interpret their self-interest in ways that conflict with the needs of government and Wall Street.
Let’s start with the recent negative rate milestone:
(Wall Street Journal) – The amount of global sovereign debt with negative yields surpassed $10 trillion for the first time in May, according to Fitch Ratings.The measure stood at $10.4 trillion on May 31, up 5% from $9.9 trillion on April 25, when the rating agency last measured the amount, according to a Thursday report. It is spread across 14 countries, with Japan by far the largest source of negative-yielding bonds. Of the total, $7.3 trillion was long-term debt and $3.1 trillion was short-term debt.
The amount of debt with yields below zero has increased sharply this year as global central banks have instituted unconventional policy measures, such as negative interest rates. The Bank of Japan in January surprised markets by driving its rates below zero, pushing Japanese government-bond yields sharply lower.
Banks in the euro currency bloc have also increased demand for government debt to meet regulatory requirements, another factor weighing on yields, Fitch said.
“Higher amounts of Japanese and Italian sovereign securities with sub-zero yields were the biggest contributors to the monthly changes,” said Fitch analysts, led by Robert Grossman.
Now — again in theory — lower interest rates are good for banks because it cuts their cost of capital and increases loan demand, making banks healthier and more valuable. But that’s not happening. Japan’s Topix bank index has fallen close to 30% this year, while the Euro Stoxx banks index is down by around 20%.
A big money manager weighed in on this paradox yesterday:
(Reuters) – Rock-bottom interest rates, with some $10 trillion of sovereign bonds carrying negative yields, are fast becoming the biggest worry for investors, asset manager Blackrock said on Thursday.“Interest rates are really starting to bite. Cash is now expensive,” said Stephen Cohen, global head of fixed income beta at the world’s largest asset manager, said at a briefing.
“Cross-border flows are being driven by ‘how do I get away from negative yields’,” he told reporters in London.
Banks are responding to the failure of their conceptual framework by trying to quit the game:
(Financial Times) – Lenders in Europe and Japan are rebelling against their central banks’ negative interest rate policies, with one big German group going so far as to weigh storing excess deposits in vaults.The move by Commerzbank to consider stashing cash in costly deposit boxes instead of keeping it with the European Central Bank came at the same time as Tokyo’s biggest financial group warned it was poised to quit the 22-member club of primary dealers for Japanese sovereign debt.
The ECB and the Bank of Japan have for months imposed negative rates for holding bank deposits in an attempt to push lenders to deploy their cash in the real economy through more aggressive lending to businesses. The policy in effect taxes banks for storing excess liquidity.
The central bank policies have hit bank profitability in both regions and German banks have been vocal in criticising Mario Draghi, ECB president, accusing him of punishing savers and undermining their business models. The policy cost German banks €248m last year, according to the Bundesbank.
Japanese banks have been more muted but Bank of Tokyo Mitsubishi UFJ has become the first leading lender to break ranks, confirming it is considering giving up its primary dealership status for sales of Japanese government bonds.
Not surprisingly, the growth that NIRP promised is also evaporating:
(Reuters) – The World Bank slashed its 2016 global growth forecast on Wednesday to 2.4 percent from the 2.9 percent estimated in January due to stubbornly low commodity prices, sluggish demand in advanced economies, weak trade and diminishing capital flows.Among major emerging market economies, the World Bank kept China’s growth forecast unchanged at 6.7 percent this year after 2015 growth of 6.9 percent. It expects China’s growth to slow further to 6.3 percent by 2018 as the world’s second-largest economy rebalances away from exports to a more consumer-driven growth model.
Let’s go through the above articles and play a game of “what’s wrong with this sentence?”:
“Higher amounts of Japanese and Italian sovereign securities with sub-zero yields were the biggest contributors to the monthly changes,” said Fitch analysts. This one’s easy: How can the world be paying Italy to borrow?? Rational investors should never, ever lend money to an entity that irresponsible and incoherent, and the idea of paying for the privilege will occupy entire chapters in future history books. The conclusion will be that today’s central banks are anything but rational.
“Cash is expensive.” Cash by definition costs nothing and yields either nothing or next to nothing. Never in living memory has it cost its owners anything (other than the secret tax of inflation). That it’s now “expensive” illustrates how much the world has changed.
The World Bank kept China’s growth forecast unchanged at 6.7 percent this year after 2015 growth of 6.9 percent. Borrowing a bunch of money and wasting it, as China has done (the big exception being its aggressive gold buying) is “growth” only in a snapshot-of-the-moment sense. In a broader time frame that includes both the spending and future cash flows from projects thus financed, China has simply impoverished the future in order to maintain a facade. Which I guess makes it a member in good standing of the modern financial system.
Anyhow, this is a story with several more chapters. And the next, very exciting one, will be the development of new policies to replace the current failures. These will — as befits the size of the problem — be breathtaking in both scope and wrong-headedness.153 views