Negative interest rates take investors into surreal territory

[JimBowerman]

 

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.

 

 

Don't necessarily disagree that some infrastructure spending would be beneficial, but i don't think we should hold out hope that fiscal policy will stoke growth.

 

There's something called the monetary offset in economics, which basically states that any increased spending on the fiscal side will be cancelled out if the monetary policy target is credible.  I like to think in extremes for though experiments: If we started running a 10% fiscal deficit, but had a 2% inflation target many would worry about upcoming inflation because of large deficits.  But the monetary authorities (in theory) could refuse to finance that deficit and stick with the 2% inflation target.  Default, etc may happen but if a central banks wants to, it can always overwhelm fiscal policy.  This is obviously a bit theoretical and in reality, politics comes into play.  But imo, the more likely real world example is that we don't default but go more the japan route where, despite a huge amount of debt, their low inflation target overwhelms any fiscal deficit/debt they've had. 

 

Would also note that if we want to stoke growth, imo monetary policy is less wasteful that fiscal policy (fiscal policy risks spending money on things that aren't needed) whereas monetary policy is more evenly distributed and less wasteful

[RuleNumberOne]

https://www.bloomberg.com/news/articles/2019-07-05/amsterdam-housing-market-gets-some-help-from-dutch-government?srnd=premium

 

"Construction costs in Amsterdam have risen 25% over the last two years.

 

median home price in the Dutch capital soared 80% in the past four years to €448,000 ($505,000)."

 

[JimBowerman]

https://www.bloomberg.com/news/articles/2019-07-05/amsterdam-housing-market-gets-some-help-from-dutch-government?srnd=premium

 

"Construction costs in Amsterdam have risen 25% over the last two years.

 

median home price in the Dutch capital soared 80% in the past four years to €448,000 ($505,000)."

 

Not sure about Amsterdam, but would guess the same applies....

 

But in New York, SF etc, construction costs (after removing costs from extra studies, etc) are relatively minor compared to final sale price

 

Its possible to build 40 story apartment buildings for $300/square foot.

 

However apartments in NYC/SF commonly sell for over $1200/square foot.  Its the constricted supply/air rights/etc that make up much of the cost, and thats only getting worse in SF/NYC (and i presume Amsterdam)

 

That said, price rises in a certain industry don't imply inflation for an economy as a whole and really don't have anything to do with monetary policy (which is the only way to create long term inflation)

 

EU and US are very unlikely to see economy wide inflation in the near or medium term, despite rises in prices in certain sectors like housing/health care/, rising oil prices/wage pressure, etc.  The oil price rises in the 1970s, and other "cost push" inflations aren't really what causes inflation. It can put pressure on the monetary authorities to print more money so unemployment doesn't rise, but its ultimately the "printing more money" which causes inflation, not the oil price rise, or the rise in housing prices, etc.

 

The monetary authorities are too scared of inflation to let it get out of control.  Will likely have to wait for the next generation of central bankers who didn't grow up in the 1970s inflation

 

edit:  To borrow from Einhorn's analogy...imagine rising oil prices, housing costs, etc as jelly donuts. Imagine the central banks inflation target as your body weight target.  Now housing costs, rising oil prices etc will certainly put pressure on inflation just as eating only jelly donuts will also put adverse pressure on reaching your weight goal.  However it is not the jelly donuts themselves that made you miss your goal weight (Some guy a few years ago actually lost weight eating only twinkies).  Now eating only twinkies/jelly donuts isn't healthy and having rapidly spiking house prices isn't healthy for an economy either (all else being equal).  But it's credibility of "the goal weight" which is paramount. It's the credibility of the inflation target which is paramount. The other stuff (i.e. jelly donuts, oil prices, house prices, etc) is just details.

 

[Spekulatius]

This feels like a missed opportunity for massive infrastructure investment like what China did since 2008 by building a national high speed railway system.

 

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.

 

It just seems like a big investment in infrastructure (high speed rail, internet/fibre/5g, airports) is quite obvious ad it will tighten labour markets, drive wages, increase inflation and interest rates and drive long-term productivity. And the market is basically saying, it'll finance it for next to nothing..

 

0 high speed rail in the US vs 428km of high-speed rail in China in 2007 to 29,000km in 2017

5 of the 6 top airports in the world are in Asia..

Fastest internet: Taiwan, Singapore, Denmark, Sweden, Japan..

 

Yes, it seems kind of crazy in Germany to not do some infrastructure investments (housing, rail etc), because in a lot of cities, the supply hasn’t kept up with demand. Fast rising housing is not popular in Germany because the percentage of homeowners is much lower than in US. Germany had a budget surplus, record low interest rates and demand that can’t be met. I instead of bitching over the negative effect of the immigration , there should be much more focus on making use of it and do what needs to be done. Seem like a no brained to build housing for a million people in cities with job growth, rail infrastructure to meet increased demand and get some of new inhabitants to work at  He same time,  instead of playing financial stimulus that doesn’t seem to do much.

 

But then again, I am not an economist.

[mcliu]

 

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.

 

 

Don't necessarily disagree that some infrastructure spending would be beneficial, but i don't think we should hold out hope that fiscal policy will stoke growth.

 

There's something called the monetary offset in economics, which basically states that any increased spending on the fiscal side will be cancelled out if the monetary policy target is credible.  I like to think in extremes for though experiments: If we started running a 10% fiscal deficit, but had a 2% inflation target many would worry about upcoming inflation because of large deficits.  But the monetary authorities (in theory) could refuse to finance that deficit and stick with the 2% inflation target.  Default, etc may happen but if a central banks wants to, it can always overwhelm fiscal policy.  This is obviously a bit theoretical and in reality, politics comes into play.  But imo, the more likely real world example is that we don't default but go more the japan route where, despite a huge amount of debt, their low inflation target overwhelms any fiscal deficit/debt they've had. 

 

Would also note that if we want to stoke growth, imo monetary policy is less wasteful that fiscal policy (fiscal policy risks spending money on things that aren't needed) whereas monetary policy is more evenly distributed and less wasteful

 

The growth isn't necessarily from the spending itself but from the productivity gains that better infrastructure will provide over the long-term.

 

It's clear that the private sector is more efficient than the government, but there are certain spending and projects that necessarily need government intervention/support.

 

In addition, markets don't always allocate resources that efficiently either.. The massive housing bubble and excessive investments in real estate is a recent example..

 

On monetary policy, wouldn't the implementation and transmission may also impact inflation and expectations? Is quantitative easing (buying bonds) the most effective way of printing money vs writing a cheque to everyone vs adding a 0 to everyone's bank accounts?

[mcliu]

This feels like a missed opportunity for massive infrastructure investment like what China did since 2008 by building a national high speed railway system.

 

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.

 

It just seems like a big investment in infrastructure (high speed rail, internet/fibre/5g, airports) is quite obvious ad it will tighten labour markets, drive wages, increase inflation and interest rates and drive long-term productivity. And the market is basically saying, it'll finance it for next to nothing..

 

0 high speed rail in the US vs 428km of high-speed rail in China in 2007 to 29,000km in 2017

5 of the 6 top airports in the world are in Asia..

Fastest internet: Taiwan, Singapore, Denmark, Sweden, Japan..

 

Yes, it seems kind of crazy in Germany to not do some infrastructure investments (housing, rail etc), because in a lot of cities, the supply hasn’t kept up with demand. Fast rising housing is not popular in Germany because the percentage of homeowners is much lower than in US. Germany had a budget surplus, record low interest rates and demand that can’t be met. I instead of bitching over the negative effect of the immigration , there should be much more focus on making use of it and do what needs to be done. Seem like a no brained to build housing for a million people in cities with job growth, rail infrastructure to meet increased demand and get some of new inhabitants to work at  He same time,  instead of playing financial stimulus that doesn’t seem to do much.

 

But then again, I am not an economist.

 

Yes exactly! It just seems so obvious..

 

All this money printing hasn't driven real productivity or real economic activity. It's just sloshing around the financial system looking for returns and driving up prices. (Not sure why though.. Maybe extreme risk-aversion, uncertainty..?)

 

It seems like an opportune time for governments to borrow big-time at negative rates and invest in long-term productivity projects..

[JimBowerman]

 

It's clear that the private sector is more efficient than the government, but there are certain spending and projects that necessarily need government intervention/support.

 

On monetary policy, wouldn't the implementation and transmission may also impact inflation and expectations? Is quantitative easing (buying bonds) the most effective way of printing money vs writing a cheque to everyone vs adding a 0 to everyone's bank accounts?

 

No disagreement on the first sentence.  Simply stating that we should do infrastructure spending where its needed logistically etc, not because we hope it will stoke inflation for the economy as a whole.

 

Imo the transmission mechanism is much less important than the credibility of the target.  if the market doesn't believe the target then it won't stoke inflation.  As an extreme, you could hand out $50,000 to everyone tomorrow but if you promised to tax that same $50,000 out of existence in 1 years time, then imo very little, if any, inflation would result. If forced to choose, i'd stick with the current system of open market operations, it works perfectly fine when the target is clear.  Its only when the target is unclear that we get bloated central bank balance sheets, etc.  Bloated CB balance sheets are a sign of failed monetary policy - expectations have not been managed and money has been too tight.  See: US, ECB, and the most extreme - Japan...Commonly, central banks with the most tight policy have the largest balance sheets.  It's very counterintuitive.

 

Inflation depends mainly on the expected long term path of the monetary base.

[John Hjorth]

Board of Governors of the Federal Reserve System [Released July 5^th 2019] : Monetary Policy Report.

 

Please note on the front cover, top right: "For use at 11:00 a.m. EDT July 5, 2019" - Incidental, huh? [same day as the job report - just a bit later.]

 

This report will be presented by Mr. Powell before the Senate Banking Committee as a testimony called "Semiannual Monetary Policy Report to the Congress" on Thursday July 11^th 2019 at 10:00 AM.

 

Summary [p. 1] :

 

Economic activity increased at a solid pace in the early part of 2019, and the labor market has continued to strengthen. However, inflation has been running below the Federal Open Market Committee’s (FOMC) longerrun objective of 2 percent. At its meeting in June, the FOMC judged that current and prospective economic conditions called for maintaining the target range for the federal funds rate at 2¼ to 2½ percent. Nonetheless, in light of  increased uncertainties around the economic outlook and muted inflation pressures, the Committee indicated that it will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near the Committee’s symmetric 2 percent objective.

 

It's exactly the same message as it basically has been for a long time from the FED. -And no talk about rate cuts.

[RuleNumberOne]

There is plenty of inflation right now. This can be proven with a simple exercise. Take the historical CPI reports of the last 10 years for the San Francisco-San Jose-Oakland metro area. In June 2017 this was 1.7%. Assuming an average of 2% for the last 10 years, it compounds to a total of 22% (I don't have the time to dig through all the 10 years of reports, but we don't need to.)

 

The cost of living in Silicon Valley has more than doubled in the last 10 years. Constructions wages, restaurant wages, tech wages, every kind of private sector wage has doubled or more. Construction costs used to be $150 per square foot earlier this decade, now it is at $350/sqft. Apartment rents have doubled. Home prices have more than doubled. But the inflation reported by the government for this metro area would be a cumulative 25% over the last 10 years.

 

Another example: If Dutch or German home prices are increasing 10%/year, and housing is 40% of the CPI basket like in the US, home prices alone would contribute 4% to the final inflation figure. Even if the rest of the CPI basket stays flat, we should be seeing 4% inflation. But these crooks use "imputed rents", and "imputed" everything wherever they can. They keep imputing 1-2% in rent inflation.

 

Then they set monetary policy based on these imaginary "imputed rents." They never measure the inflation in home prices or stock prices or bond prices when justifying their monetary policy. Instead they point to stuff of their imagination - such as "imputed costs", "imputed rents", "hedonic adjustments", "substitution effects" and such other nonsense used in inflation calculations.

 

I bring this up to help us identify inflection points. When we have misallocation of capital, and things get completely out of wack, the bubble has to pop. Identifying the dislocation before it happens can save or make a lot of money. I don't see how the home price boom can continue in Europe for long while the governments wring their hands about "inflation less than 2%" and keep rates negative. Reality becomes unmoored from the fake inflation figures.

 

 

https://www.bloomberg.com/news/articles/2019-07-05/amsterdam-housing-market-gets-some-help-from-dutch-government?srnd=premium

 

"Construction costs in Amsterdam have risen 25% over the last two years.

 

median home price in the Dutch capital soared 80% in the past four years to €448,000 ($505,000)."

 

Not sure about Amsterdam, but would guess the same applies....

 

But in New York, SF etc, construction costs (after removing costs from extra studies, etc) are relatively minor compared to final sale price

 

Its possible to build 40 story apartment buildings for $300/square foot.

 

However apartments in NYC/SF commonly sell for over $1200/square foot.  Its the constricted supply/air rights/etc that make up much of the cost, and thats only getting worse in SF/NYC (and i presume Amsterdam)

 

That said, price rises in a certain industry don't imply inflation for an economy as a whole and really don't have anything to do with monetary policy (which is the only way to create long term inflation)

 

EU and US are very unlikely to see economy wide inflation in the near or medium term, despite rises in prices in certain sectors like housing/health care/, rising oil prices/wage pressure, etc.  The oil price rises in the 1970s, and other "cost push" inflations aren't really what causes inflation. It can put pressure on the monetary authorities to print more money so unemployment doesn't rise, but its ultimately the "printing more money" which causes inflation, not the oil price rise, or the rise in housing prices, etc.

 

The monetary authorities are too scared of inflation to let it get out of control.  Will likely have to wait for the next generation of central bankers who didn't grow up in the 1970s inflation

 

edit:  To borrow from Einhorn's analogy...imagine rising oil prices, housing costs, etc as jelly donuts. Imagine the central banks inflation target as your body weight target.  Now housing costs, rising oil prices etc will certainly put pressure on inflation just as eating only jelly donuts will also put adverse pressure on reaching your weight goal.  However it is not the jelly donuts themselves that made you miss your goal weight (Some guy a few years ago actually lost weight eating only twinkies).  Now eating only twinkies/jelly donuts isn't healthy and having rapidly spiking house prices isn't healthy for an economy either (all else being equal).  But it's credibility of "the goal weight" which is paramount. It's the credibility of the inflation target which is paramount. The other stuff (i.e. jelly donuts, oil prices, house prices, etc) is just details.

[JimBowerman]

RuleNumberOne,

 

Not to deflect and I’d be happy to continue this further but the whole shadow stats conspiracy has largely been debunked imo.  Someone a while back even went back and looked at the subscription prices for shadow stats.com and found the dude hadn’t even increased subscription prices at the same rate as his implied super high inflation rate. He increased prices at the much lower rate implying inflation was lower than he guessed.

 

Scott sumner (who has forgotten more about economics than I’ll ever know) debunked a similar argument as yours from peter Schiff all the way back in 2013 (see video below)

 

Summers basic point is that if inflation is really as high as you and schiff claim then rgdp would have to be negative or very low.  Something that is very unlikely given the unemployment numbers.  You basically have to believe the government is outright lying across multiples surveys (ngdp, unemployment, etc). Even sp500 revenues do to show anywhere near the inflation your claiming

 

[RuleNumberOne]

@JimBowerman

 

I propose an even simpler exercise for some aspiring economist/intern.

 

1. Call up 2 real estate agents in the Bay Area, we can get their numbers from mlslistings.com. Ask them:

 

    -  How much was the construction cost per sqft in 2011? How much is it today? Gone up 2x?

 

2. Call up 2 apartment complexes in the Bay Area. Ask them:

 

    -  How much was your rent in 2011? How much is it today? Gone up 2x?

 

3. Then ask Jim Bullard why the CPI for the San Francisco - San Jose metro area for the last 8 years is so low when rents and home prices went up so much? Housing is > 40% of the US CPI basket.

 

If housing is 42% of the CPI basket, and rents went up even 7% per year, housing alone would contribute 2.94% to CPI. What tricks did the BLS use to whack it down to 1.5%?

 

W.r.t your point about S&P revenues, I think S&P domestic revenue fluctuations (both upwards and downwards) have a larger inflation component than government figures (think about it from the viewpoint of bubbles and busts, a chart of S&P sales over time shows this.)

 

W.r.t your point about rgdp, the gdp figures get revised for many years afterwards because the government has no idea. The gdp figures at any given time are nothing but a guess. The inflation component in nominal gdp is likely larger than what is currently claimed.

 

BTW, off-topic, but I don't pay any attention to what Sumner/Schiff/shadowstats say. I look at first-hand data myself and come up with first-principle explanations.

 

 

RuleNumberOne,

 

Not to deflect and I’d be happy to continue this further but the whole shadow stats conspiracy has largely been debunked imo.  Someone a while back even went back and looked at the subscription prices for shadow stats.com and found the dude hadn’t even increased subscription prices at the same rate as his implied super high inflation rate. He increased prices at the much lower rate implying inflation was lower than he guessed.

 

Scott sumner (who has forgotten more about economics than I’ll ever know) debunked a similar argument as yours from peter Schiff all the way back in 2013 (see video below)

 

Summers basic point is that if inflation is really as high as you and schiff claim then rgdp would have to be negative or very low.  Something that is very unlikely given the unemployment numbers.  You basically have to believe the government is outright lying across multiples surveys (ngdp, unemployment, etc). Even sp500 revenues do to show anywhere near the inflation your claiming

 

[John Hjorth]

Carried to here from the "1999 again?" topic:

 

If Danish mortgage rates are at -0.43%, are deposit rates even more negative?

 

If they are not, on a 30 year mortgage, the bank would lose -13% (since the negative rate is implemented by forgiving -0.43% of the loan every year.)

 

I really liked that Bloomberg article headline about the stimulus - "won't say when or how." Not sure if the bears will continue to believe there are bullets in Draghi's gun.

 

The bond bears can make a killing, duration has increased so much that a one percent interest rate increase results in $2.4 trillion in sovereign debt losses alone. Not to mention home price implosion.

You need to understand the Danish mortgage system. It's not financed by deposits, but by mortgage bonds, ref. also what kab60 has mentioned before in this topic.

 

Here is link to the 2018 financials for Realkredit Danmark A/S. Realkredit Danmark A/S is a wholly owned subsidiary of Danske Bank A/S. As a mortgage institution, Realkredit Danmark A/S is separately regulated, while the bank is separately regulated as bank.

 

Please take a look at page 2 - I'll translate for you :

 

Realkredit Danmark A/S generated a profit for 2018 of DKK 4.649 B [included in the group profit for Danske Bank A/S for 2018]

"Realkreditudlån" : Mortgage loans [for YE2018 : DKK 796.045 B]

"Udstedte realkreditobligationer" : Issued mortgage bonds [for YE2018 : DKK 809.091 B]

- - - o 0 o - - -

 

Wikipedia : Mortgage industry of Denmark.

 

Edit:

 

Finance Denmark : The Danish Mortgage Model.

 

[RuleNumberOne]

Danske Bank also publishes English statements. They do have deposits, though they also have an equal amount of mortgage bonds.

 

Either way, this is a forced transfer from bondholders or depositors to homebuyers.

 

It is like a bondholder buying a house for $2million, selling it to the homebuyer for $1.7 million, and paying the bank $100,000 in commissions.

 

The cost of this negative rate stuff in creating these distortions is greater than the benefits (I believe a housing bubble is the benefit?). ECB is out of ammo.

[Cigarbutt]

Surreal may become an insufficient qualitative word at some point:

https://www.ft.com/content/6cee154a-a307-11e9-974c-ad1c6ab5efd1

[John Hjorth]

Finanswatch [July 11^th 2019] : Nationalbanken [<- The Danish FED, John] about low interest rates : Not the fault of the central banks.

 

Danmarks Nationalbank [June 27^th 2019] : Analysis - The natural real interest rate in Denmark has declined.

 

Personally, I consider this at least a decent stab at getting to an explanation of this phenomen. It also reminds me of a post recently by Cigarbutt about the long term development in interest rates.

 

It's not all negatives. The analysis implies, that it - among other things - has to do with high savings rates in the Danish households after the GFC [please note here : at a total level]. Consumption folly [perhaps even for borrowed money] hasn't really arrived here - at least yet.

[John Hjorth]

I'm carrying your post in the WFC topic over here, for commentary, RuleNumberOne,

 

Negative rates have not been proven to work yet. Bernanke and Greenspan have said they don't think it is useful. Bernanke says at some point people will simply hoard cash.

 

I am not sure how Denmark is forcing people to accept negative rate mortgage bonds. Or how the European Project is forcing people to buy negative rate sovereign debt. As soon as the rate goes negative, one might as well leave their money as cash? Cash is better than any negative rate bond? Unless you force pension funds, university endowments to buy bonds with their cash?

 

https://www.marketwatch.com/story/alan-greenspan-comes-out-against-using-negative-rates-2016-03-01

https://www.marketwatch.com/story/bernanke-says-fed-likely-to-add-negative-rates-to-recession-fighting-toolkit-2015-12-15

 

In Europe, it is probably part of the "whatever it takes" to keep Italy and Greece in the European Project. I haven't seen any explanation of how it benefits the economy.

 

Europe bond bubble will blow up eventually.

You're certainly up to something right here, RuleNumberOne,

 

This post is only about Danish conditions.

 

The answer to your question here is : They don't [buy these bonds with negative yields]. The outcome has been that the Danish banks are literally swimming in cash - some of them are almost drowning in it. The more conservative the bank is run, more worse it gets.

 

I have read somewhere, that the Danish banks holds retail [household] deposits of ~DKK 900 B. What does a Danish bank do with all its cash, when it gets "punished" by Danmarks Nationalbank [The Danish FED] with an interest rate of minus 0.65 percent if it deposits its liquidity there, when it can't expand its loan underwriting/loan book because of very strict lending policies surveyed by the relentless and pretty brutal Danish FSA with inspections of the loan book, giving orders and fines and such when things aren't done OK? -Furthermore the actual demand for credit from Danish households has been languishing for many years - in general, the Danes have been paying down their debt, and accumulating funds for a rainy day.

 

The banks only alternative is to buy bonds. So there are large bond positions on the balance sheets of Danish banks - to varying degrees. To at least get some yield from these bonds, the banks have to buy bonds with at least some duration. That again requires capital buffers to withstand [sudden?] rate spikes in the bond market, or else the bank may be forced to reduce its balance sheet [by selling bonds] at the exact wrong time [the price bottom].

 

- - -  o 0 o - - -

 

Some data:

 

So far, I haven't been able to find some data from what I consider a reliable primary source for Danish retail [household] deposits in banks, that I'm sure of, and understand with precision. So here comes a rough, quick & dirty estimate of that figure:

 

Source: Danske Bank A/S Factbook Q1 2019.

 

Deposits [section 1.7.2 at page 11] :

 

Retail : DKK 208.0 B

Wealth Management : DKK 70.9 B

Total : DKK 278.9 B

 

Market share [section 4.1 at page 41] :

 

Retail : 28.5 percent,

 

Thus : Total retail [household] deposits in Danish banks ~ DKK 278.9 B / 28.5 percent ~ DKK 978 B

 

- - - o 0 o - - -

 

An extreme example of a Danish bank in this situation :

 

Fynske Bank A/S [ticker : FYNBK.CPH] : [source : 2019Q1 10-K].

 

Equity : DKK 1,053 M

Loan book : DKK 3,255 M

Deposits : DKK 5,406 M

Bonds : DKK 2,495 M.

 

Some days I really can't decide if this bank is a bond portfolio with a bank glued to the bond portfolio, or "just" a bank with a big bond portfolio.

 

- - - o 0 o - - -

 

The above cash deposits estimate has to be judged relative to total mortgage loans in the Danish mortgage institutions of DKK 1,609 B in Danish homes and recreational homes, plus second layer house financing provided by the banks to households. What matters for the financial stability of the whole system is naturally how these assets and liabilities are distributed among the citizens of the nation.

[SHDL]

So today (a) the CPI report showed signs of an uptick in inflation, and (b) long term Treasury yields went up following an auction of 30-year bonds that didn’t go so well.  Yes, this could be just noise but they are still interesting data points because they suggest that things might actually be moving in the opposite direction of what a lot of people seem to be expecting.

[Cigarbutt]

Finanswatch [July 11^th 2019] : Nationalbanken [<- The Danish FED, John] about low interest rates : Not the fault of the central banks.

 

Danmarks Nationalbank [June 27^th 2019] : Analysis - The natural real interest rate in Denmark has declined.

 

Personally, I consider this at least a decent stab at getting to an explanation of this phenomen. It also reminds me of a post recently by Cigarbutt about the long term development in interest rates.

 

It's not all negatives. The analysis implies, that it - among other things - has to do with high savings rates in the Danish households after the GFC [please note here : at a total level]. Consumption folly [perhaps even for borrowed money] hasn't really arrived here - at least yet.

That was an interesting read and it seems to fit with consensus thinking among central bankers with, for example, Mr. Bernanke suggesting over the years that real yields are getting lower in developed countries because of maturing age cohorts and search for yield coming from the savings glut.

Just like deflation I guess, there could be 'good' and 'bad' reasons behind low interest rates.

 

When people try to get to the top of Mount Everest, gradually declining oxygen levels tend to send a signal to the hiker that the safe limit has been reached, necessitating to abandon the cherished goal. Interestingly, at some point, there is a phase when low levels of oxygen causes cerebral edema and confusion and the safety signal is lost and, without proper sherpa people restraint, people become filled with overconfidence and think they can reach the top at a time when they should retreat. Maybe the sky is the limit.

 

If interested, Hoisington Investment Management, which used to be a significant source of inputs for Fairfax, released yesterday their Q2 report. They continue to think that yields are heading, eventually, lower.

www.hoisingtonmgt.com/pdf/HIM2019Q2NP.pdf

[JimBowerman]

 

That was an interesting read and it seems to fit with consensus thinking among central bankers with, for example, Mr. Bernanke suggesting over the years that real yields are getting lower in developed countries because of maturing age cohorts and search for yield coming from the savings glut.

Just like deflation I guess, there could be 'good' and 'bad' reasons behind low interest rates.

 

Money is neutral in the long run...That is, over the long run, nominal interest rates don't affect real variables.

 

That said, as Scott Sumner says, in the short and medium term, nominal shocks have real effects (because of sticky wages) so imo the main argument should be to keep nominal growth rates as stable as possible (which central banks have failed miserably at over the last 20 years)

 

When looking at nominal growth rate stability (and its correlation to real growth rates) I have to believe we can do better

 

That said, yes, real growth rates (because of slower population growth) should be lower going forward...but that's no excuse for lower nominal growth rates nor more volatile nominal growth rates going forward (both of which a central bank almost completely controls)

 

[RuleNumberOne]

If I were to run a bank in a negative-rate economy, I would not make any mortgages.

 

I would just keep the deposits in a -10bp fee account, where the 10bp pays for expenses and profits. On 900billion, that is 900 million per year.

 

All that the bank would do is accept direct deposits of paychecks, wire transfers, checks. It would also provide ATMs for a fee.

 

The above setup is very profitable. No loan risk, just a nice fee like Visa/Mastercard. If you want, don't even call it a bank. Call it a cash management company.

 

I presume the government in a negative-rate economy has to force banks and insurance companies, pension funds to buy bonds and make loans. Kind of like a dictatorship, otherwise the economy would look worse than the Great Depression.

 

 

I'm carrying your post in the WFC topic over here, for commentary, RuleNumberOne,

 

Negative rates have not been proven to work yet. Bernanke and Greenspan have said they don't think it is useful. Bernanke says at some point people will simply hoard cash.

 

I am not sure how Denmark is forcing people to accept negative rate mortgage bonds. Or how the European Project is forcing people to buy negative rate sovereign debt. As soon as the rate goes negative, one might as well leave their money as cash? Cash is better than any negative rate bond? Unless you force pension funds, university endowments to buy bonds with their cash?

 

https://www.marketwatch.com/story/alan-greenspan-comes-out-against-using-negative-rates-2016-03-01

https://www.marketwatch.com/story/bernanke-says-fed-likely-to-add-negative-rates-to-recession-fighting-toolkit-2015-12-15

 

In Europe, it is probably part of the "whatever it takes" to keep Italy and Greece in the European Project. I haven't seen any explanation of how it benefits the economy.

 

Europe bond bubble will blow up eventually.

You're certainly up to something right here, RuleNumberOne,

 

This post is only about Danish conditions.

 

The answer to your question here is : They don't [buy these bonds with negative yields]. The outcome has been that the Danish banks are literally swimming in cash - some of them are almost drowning in it. The more conservative the bank is run, more worse it gets.

 

I have read somewhere, that the Danish banks holds retail [household] deposits of ~DKK 900 B. What does a Danish bank do with all its cash, when it gets "punished" by Danmarks Nationalbank [The Danish FED] with an interest rate of minus 0.65 percent if it deposits its liquidity there, when it can't expand its loan underwriting/loan book because of very strict lending policies surveyed by the relentless and pretty brutal Danish FSA with inspections of the loan book, giving orders and fines and such when things aren't done OK? -Furthermore the actual demand for credit from Danish households has been languishing for many years - in general, the Danes have been paying down their debt, and accumulating funds for a rainy day.

 

The banks only alternative is to buy bonds. So there are large bond positions on the balance sheets of Danish banks - to varying degrees. To at least get some yield from these bonds, the banks have to buy bonds with at least some duration. That again requires capital buffers to withstand [sudden?] rate spikes in the bond market, or else the bank may be forced to reduce its balance sheet [by selling bonds] at the exact wrong time [the price bottom].

 

- - -  o 0 o - - -

 

Some data:

 

So far, I haven't been able to find some data from what I consider a reliable primary source for Danish retail [household] deposits in banks, that I'm sure of, and understand with precision. So here comes a rough, quick & dirty estimate of that figure:

 

Source: Danske Bank A/S Factbook Q1 2019.

 

Deposits [section 1.7.2 at page 11] :

 

Retail : DKK 208.0 B

Wealth Management : DKK 70.9 B

Total : DKK 278.9 B

 

Market share [section 4.1 at page 41] :

 

Retail : 28.5 percent,

 

Thus : Total retail [household] deposits in Danish banks ~ DKK 278.9 B / 28.5 percent ~ DKK 978 B

 

- - - o 0 o - - -

 

An extreme example of a Danish bank in this situation :

 

Fynske Bank A/S [ticker : FYNBK.CPH] : [source : 2019Q1 10-K].

 

Equity : DKK 1,053 M

Loan book : DKK 3,255 M

Deposits : DKK 5,406 M

Bonds : DKK 2,495 M.

 

Some days I really can't decide if this bank is a bond portfolio with a bank glued to the bond portfolio, or "just" a bank with a big bond portfolio.

 

- - - o 0 o - - -

 

The above cash deposits estimate has to be judged relative to total mortgage loans in the Danish mortgage institutions of DKK 1,609 B in Danish homes and recreational homes, plus second layer house financing provided by the banks to households. What matters for the financial stability of the whole system is naturally how these assets and liabilities are distributed among the citizens of the nation.

[RuleNumberOne]

This is the Second Tulip Bubble. Investors trading paper at higher and higher prices.

 

https://www.wsj.com/articles/oxymoron-alert-some-high-yield-bonds-go-negative-11563096601?mod=hp_listb_pos3

"“And just because something is negative yielding, that doesn’t mean it can’t get more negative yielding.” Falling yields mean rising bond prices and gains for investors, at least on paper."

 

“I expect to have a high-yield company issue a negative-yielding bond,” said Martin Reeves, head of high yield at Legal & General Investment Management."

 

 

Why don't these investors trade my paper: bonds issued by my Smoke Weed All Day Inc. are rated AAAAA++. The money lent by investors goes straight into an escrow account from where it will be refunded upon maturity. Safer than Treasuries, you never have to worry about entitlement spending.

 

We don't touch any of the principal. We just use the -0.01% interest to buy weed and smoke it, thereby stimulating the farming economy hurt by the trade war and also raising GDP.

 

If you get in on the ground floor of -0.01% yield, you may be able to trade it all the way up to a yield of -10% in the coming weeks.

[RuleNumberOne]

https://www.ft.com/content/f176544a-a6ee-11e9-b6ee-3cdf3174eb89

 

"The fall in yield has pushed the gap between seven-year Greek and German debt — seen as a key barometer of the perceived risk of holding the paper — to around 1.8 percentage points, from 4 points late last year."

 

Are spreads between Greek and German debt headed to 0?

[JimBowerman]

Everyone seems to think that low nominal yields imply "free money" or "central bank manipulation", but let's look at some historical data and see if there's really any difference between say 1960-2005 vs 2005-2018.  At least compared to the pre 2005 era, have central banks really started printing more "free money" since 2005?

 

From 1915 to 2000, US nominal GDP averaged about 6.75% and 10 year bond yields averaged 5.5% or so.  Given 4% or so NGDP going forward, are 2.5% bond yields really implying "Free money"?  Or these low yields simply a continuation of the pattern of bond yields averaging a bit less than expected NGDP growth going forward? I'd argue it's the latter....

 

Next let's look at Germany. German NGDP averaged about 8.5% from 1960 to 2005. During that time, German 10 year bonds averaged about 6.75%. Since 2005, German NGDP has averaged a paltry 3.0% with German bond yields averaging about 2.25% during that time frame. If anything one could argue that German NGDP will be lower than even 3% going forward, so the 0% bond yields don't seem extremely out of the ordinary. Possibly a bit low, but given other EU bank regulations etc, it's far from abnormal.  What would be abnormal is significantly higher German bond yields given the unlikelihood of higher German NGDP going forward.  If folks are going to argue for higher German bond yields, then first they need to explain why German NGDP will be higher going forward. 

 

In my opinion the ECB has shown few (if any) signs that they desire higher NGDP growth going forward, making the low EU yields about right in my opinion. 

 

Far from "Free money", the low EU yields accurately reflect the low EU NGDP expectations going forward

[RuleNumberOne]

Great article about how negative rates in Europe benefit only bond investors but hurt everything else:

 

https://www.ft.com/content/395f450c-a3be-11e9-974c-ad1c6ab5efd1

 

"The soft patch in Europe has investors clamouring for the ECB to act — yet not one of those same investors believes interest rate cuts or quantitative easing will have a beneficial impact.

 

Aside from throwing a festival for fixed-income investors there appear to be very few benefits and high risks from ECB action. Central banks are obsessed with credibility and power. They may not be able to turn a blind eye to a slowdown, but do they really want to reveal the impotence of their current policy tools?"

 

 

[RuleNumberOne]

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?