Get ready for negative interest

[Mulligan]

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Originally Posted by Another Reader Negative interest rates? Time to deleverage. Paying off my rental mortgages is looking like a nice guaranteed return at this point. Don't let the bank take your money, pay off all debt with a rate higher than zero. Only have the minimum cash in the bank needed to get by, and buy a new mattress to hoard the cash on hand at home.

Your above reason is why I have been buying a lot of KTH, trust preferred baby bond from PECO energy, Another. I am getting a current 6.4% yield, and the issue is noncallable until 2028. 6% with an investment grade Moody's A3 rated bond. Appears to me anyways an example of one way to avoid the zero rate blues. If I had rentals I would definitely think about what you are doing.


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[Gone4Good]

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Originally Posted by Mulligan I agree your background basis and theory are correct. But...Here is the question I don't understand... By numerical data anyways, the economy is not that bad to do that drastic of measures is it?

Nope, the economy isn't that bad. And that's why the U.S. currently doesn't have negative nominal rates.

But here's the thing. We're ~7 years into economic recovery. Unemployment just ticked below 5%. The equity market as of a few months ago was making new highs. The Fed has been doing everything in its power to raise growth and stoke some inflation since 2007-8 . . .

And in the face of all that 10 year inflation expectations (measured as the difference between 10-yr treasury bonds and TIPS) is just 1.2% today. Let me say that again for emphasis. Bond investors are betting that U.S. inflation will average just 1.2% over the next decade even though the Fed is committed to a 2% inflation target.

Something ain't right.

And now, after 7 years of "recovery", we're at what is typically the tail end of a normal economic expansion. What happens if the U.S. does tip into a "normal" recession in light of where we are at the peak of this expansion?

Is U.S. deflation so hard to imagine?

Might it not be wise to lay the groundwork for the tools that may be necessary if that should come to pass even if they're not needed at this precise moment?

Because once deflation takes hold, how exactly do we get ourselves back out?

[Mulligan]

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Originally Posted by Gone4Good Nope, the economy isn't that bad. And that's why the U.S. currently doesn't have negative nominal rates. But here's the thing. We're ~7 years into economic recovery. Unemployment just ticked below 5%. The equity market as of a few months ago was making new highs. The Fed has been doing everything in its power to raise growth and stoke some inflation since 2007-8 . . . And in the face of all that 10 year inflation expectations (measured as the difference between 10-yr treasury bonds and TIPS) are just 1.2% today. Let me say that again for emphasis. Bond investors are betting that U.S. inflation will average just 1.2% over the next decade even though the Fed is committed to a 2% inflation target. Something ain't right. And now, after 7 years, we're at what is typically the tail end of a normal economic expansion. What happens if the U.S. does tip into a "normal" recession in light of where we are at the peak of this expansion? Is U.S. deflation so hard to imagine? Might it not be wise to lay the groundwork for the tools that may be necessary if that should come to pass even if they're not needed at this precise moment?

Good discussion here, just want to emphasize not being aurgumentive, just fleshing out thoughts... The bond investors were betting in the early 80's inflation would be around 10% for 10 years and that didn't happen.I dont believe negative interest rates have ever proven to have been used before, so it would just be a "hope and pray" mission correct? Law of Unintended consequences may well come into play. We see what low interest rates did for debt fueled oil companies. Mlp's did the same thing and now its falling into their lap, too. Even if rates are lower the cash starved companies cannot get access to capital at a low rate presently. Two years ago high yield bond index was in the 5's, now its near 10%. Pristine balance sheet companies paying dividends, will just load up on debt to buy shares instead of expanding little needed capacity, because debt payment will be lower than dividend obligation. Barter economy could emerge. Im just brainstorming here... The fundamental problem I see (only my opinion of course), is world overproduction capacity and technology too efficient that destroys more jobs, than creates. I don't see negative interest rates addressing the fundamental problem.
Now, I admit I have been in the "lower for longer" camp even when everyone was claiming rates were going up last year. I have had almost all of my money in investment grade utility preferred stocks the past 2 years and they only "work" in a low interest rate environment, so I agree with you when I believe market forces are also at play with lower rates.


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[Gone4Good]

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Originally Posted by Mulligan The bond investors were betting in the early 80's inflation would be around 10% for 10 years and that didn't happen.I dont believe negative interest rates have ever proven to have been used before, so it would just be a "hope and pray" mission correct? Law of Unintended consequences may well come into play. We see what low interest rates did for debt fueled oil companies.

Yup, the bond market ain't God. And bond investors may well get their asses handed to them on this. It's just one indicator. Another indicator is trailing 12 month CPI at just 0.7% . . . with unemployment of 4.9%

So, like I said, something ain't right.

But I agree unintended consequences are a concern. Doing something that's never been done before is especially risky. Which is why the Fed will move slooooowly, if at all on this.

We're seeing a bit of fall out already with folks worrying about bank profitability because of slightly negative rates around the world. That seems to me to be nothing more than an adjustment issue, but we'll see.

I can't actually believe that having to pay 0.0025% on excess reserves is going to tank a business model that isn't already broken. Maybe banks could try the revolutionary concept of making some loans with that cash. Or if they can't do that, maybe they could stop paying better than treasury rates on CDs and time deposits. Or, if that doesn't do the trick, perhaps they could start charging folks for deposits. What are they sitting on piles of cash for anyway? If they can't do something with it, charge customers for the privilege of holding it and it will go somewhere else . . . which is all kind of the point.

As for oil company debt? Mmmm, I wouldn't lay that at the feet of the Fed. It's not like this is the first time we've seen commodity companies misjudge the cycle and go belly up. I kind of think that's what they're on earth to do.

But yeah, there will be unintended consequences. We learn, after all, by doing. But the prospect for unintended consequences never really goes away. Sometimes its easy to forget, doing nothing has risks too.

[Mulligan]

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Originally Posted by Gone4Good Yup, the bond market ain't God. And bond investors may well get their asses handed to them on this. It's just one indicator. Another indicator is trailing 12 month CPI at just 0.7% . . . with unemployment of 4.9% So, like I said, something ain't right. But I agree unintended consequences are a concern. Doing something that's never been done before is especially risky. Which is why the Fed will move slooooowly, if at all on this. We're seeing a bit of fall out already with folks worrying about bank profitability because of slightly negative rates around the world. That seems to me to be nothing more than an adjustment issue, but we'll see. I can't actually believe that having to pay 0.0025% on excess reserves is going to tank a business model that isn't already broken. Maybe banks could try the revolutionary concept of making some loans with that cash. Or if they can't do that, maybe they could stop paying better than treasury rates on CDs and time deposits. Or, if that doesn't do the trick, perhaps they could start charging folks for deposits. What are they sitting on piles of cash for anyway? If they can't do something with it, charge customers for the privilege of holding it and it will go somewhere else . . . which is all kind of the point. As for oil company debt? Mmmm, I wouldn't lay that at the feet of the Fed. It's not like this is the first time we've seen commodity companies misjudge the cycle and go belly up. I kind of think that's what they're on earth to do. But yeah, there will be unintended consequences. We learn, after all, by doing. But the prospect for unintended consequences never really goes away. Sometimes its easy to forget, doing nothing has risks too.

I didn't mean to imply the Fed was to blame for overzealous investing at low rates. I guess what I was trying to imply is easy access to low interest rates can create bubbles and over extension of debt. We have seen that before in the housing market with people qualifying for mortgages without means to pay. Im not versed enough to know if lack of bank loaning is a problem. There are many ways for businesses and people to access capital through private funding, internet funding, BDC's etc. In fact many are being viewed as a long term threat to traditional banks. The average American consumer certainly doesnt need to be goosed to spend as their debt levels are pretty high and cash reserves low. Like I said, not really disagreeing with you, and your thoughts are sound, I just sense it is a pushing on a string thing.


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[gcgang]

Meb Faber Research - Stock Market and Investing Blog - Stock Market and Investing Blog of Meb Faber Meb Faber Research – Stock Market and Investing Blog

Above link to Meb Faber shows 13 countries, mostly European, currently have negative rates on their 2 year gov notes. His Whitepaper is an interesting read.

To fully give Central Banks the ability to utilize negative rates it is helpful to get rid of physical currency.

[Amethyst]

Robbers alert: People will soon be hiding more cash in their mattresses than ever before!

[Gone4Good]

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Originally Posted by Mulligan I guess what I was trying to imply is easy access to low interest rates can create bubbles and over extension of debt.

Yes it can and it certainly has. It's a fair observation, but what's to be done about it?

We all know that since the 1980's interest rates have been on a persistent downward trend. For a while, that seemed just like a return to normal after a period of high inflation.

But real rates have consistently declined during that time too. Each expansion results in lower peak interest rates and each recession in lower troughs. I know folks like to blame the Fed for all the world's ills, but it's pretty clear they're just following the market lower.

And now we've arrived at a point where the 10-year real interest rate during a period of full employment is only 0.5%. That will certainly inflate asset values which will have the ancillary effect of creating some bubbles too. I'm just not sure what the alternative is.

[Mulligan]

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Originally Posted by Gone4Good Yes it can and it certainly has. It's a fair observation, but what's to be done about it? We all know that since the 1980's interest rates have been on a persistent downward trend. For a while, that seemed just like a return to normal after a period of high inflation. But real rates have consistently declined during that time too. Each expansion results in lower peak interest rates and each recession in lower troughs. I know folks like to blame the Fed for all the world's ills, but it's pretty clear they're just following the market lower. And now we've arrived at a point where the 10-year real interest rate during a period of full employment is only 0.5%. That will certainly inflate asset values which will have the ancillary effect of creating some bubbles too. I'm just not sure what the alternative is.

There are some alternative strategies being thrown out there, but that heads way over into the political persuasion, and I am not going there!


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[dallas27]

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Originally Posted by jim584672 Well banks have vaults, so get the notes and put them in the vault, problem solved.

Lol, very little money is physical, most is imaginary through the multiplier.


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[John Galt III]

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Originally Posted by jim584672 Who is willing to pay someone to hold their money? And have the risk involved with a loan?? Makes no sense and can't work. People will just hoard physical cash.

Another thing that doesn't make sense about negative interest rates: The Fed is going pay banks to accept a zero interest loan? Or will the Fed give the banks the zero interest loan, then only expect most of it to be repaid, but not all of it

[Gone4Good]

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Originally Posted by John Galt III Another thing that doesn't make sense about negative interest rates: The Fed is going pay banks to accept a zero interest loan? Or will the Fed give the banks the zero interest loan, then only expect most of it to be repaid, but not all of it

Mostly the Fed takes deposits from banks in the form of reserves. It would charge banks a fee for the privilege of holding those reserves at the Fed.

The Fed doesn't typically make loans to banks, although in times of troubles it can. The Fed requires collateral for its loans and charges a "penalty rate" of interest on the money it lends so banks don't typically borrow from the Fed.

Said another way, the Fed charges above market rates for its loans. So I don't see many conceptual problem at negative rates that wouldn't also apply at positive ones - potential cash hording aside.

[Whisper66]

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Originally Posted by Gone4Good Mostly the Fed takes deposits from banks in the form of reserves. It would charge banks a fee for the privilege of holding those reserves at the Fed.

Lost me on this one. What benefit does the bank have for depositing with Feds for a fee....rather than just keeping the funds on their own books?

[Gone4Good]

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Originally Posted by Whisper66 Lost me on this one. What benefit does the bank have for depositing with Feds for a fee....rather than just keeping the funds on their own books?

All bank reserves are held at the Fed. The alternative is to hold cash in the vault, but there isn't as much space as you'd think and the costs / logistics of moving billions and trillions in physical currency isn't a small consideration.

From an ECB presentation . . .

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There is a cost of storing, holding, and more importantly, using physical currency. This involves the cost of renting, maintaining and securing storage facilities such as vaults as well as the cost of shipping currency around in a safe and timely manner. A recent ECB study estimated the private cost of cash payments to be 1.1% of GDP on average in the participating countries. The unit social cost was estimated at 2.3 cents per euro of transaction. This is substantially higher than the unit social cost of a credit transfer or other non-cash means of payments per euro of transaction.

And if a Central Bank were serious about imposing negative interest rates, they could raise those costs further by imposing fees to access new printed notes. "You want a $100 note. No problem, sir. There's just the small matter of our printing fee to settle."

Of course there are limits to how negative rates can go before people start pricing transactions in cigarettes. But nobody is suggesting massively negative rates. We're currently talking about fractions of a percent to maybe as high as a couple percent.

[Gone4Good]

One more interesting thing to note. Sweden is among the most aggressive in pushing rates below zero. Could that be in part because Swedes are increasingly abandoning cash altogether.

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Parishioners text tithes to their churches. Homeless street vendors carry mobile credit-card readers. Even the Abba Museum, despite being a shrine to the 1970s pop group that wrote “Money, Money, Money,” considers cash so last-century that it does not accept bills and coins. Few places are tilting toward a cashless future as quickly as Sweden, which has become hooked on the convenience of paying by app and plastic.

Cash is so last century. So, too, I suspect is the "lower zero bound" on interest rates.

[samclem]

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Originally Posted by Gone4Good Cash is so last century. So, too, I suspect is the "lower zero bound" on interest rates.

Governments hate cash. It's expensive to print, to maintain, and to destroy.

More importantly, it allows people to conduct transactions totally anonymously, it's virtually impossible to track the movements of people and their purchases if they use cash. A person can also just keep it--a totally liquid and easily transportable store of wealth that can be used everywhere without any records while it is being stored. Authorities hate that.
If a person has done nothing wrong, they shouldn't have any objection to having their activities tracked, right?

[Gone4Good]

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Originally Posted by samclem Governments hate cash.

I hate cash.

I never use it unless I have to. It's inconvenient, unsecure, and doesn't even earn me free flights.

I also hate standing in line behind other people using it. The only thing worse than seeing someone pull out a change purse at the register is watching them pull out a checkbook.

And if I cared about who was tracking me I'd stay off the internet and sure as #$^% wouldn't carry or use a smart phone.

Bring on the digital revolution. Down with cash.

[MichaelB]

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Originally Posted by Gone4Good One more interesting thing to note. Sweden is among the most aggressive in pushing rates below zero. Could that be in part because Swedes are increasingly abandoning cash altogether.

Not really. Negative rates are more about the banking system. As the ECB pushes down it's own rates, the strong currency countries such as Sweden and Switzerland have to follow suit or their currencies appreciate.

[samclem]

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Originally Posted by Gone4Good I hate cash.

People say they hate it, but they'll never give me theirs!

I do think it is a good idea to keep enough of the green stuff around to get through "trouble" (power/ATM machines down, any short term problem with CC processor's IT systems, etc). And the amount of cash people will want to keep around increases as the perceived likelihood of "trouble" widens and deepens.

[VFK57]

And now, after 7 years of "recovery", we're at what is typically the tail end of a normal economic expansion. What happens if the U.S. does tip into a "normal" recession in light of where we are at the peak of this expansion?
Seven years of recovery was was fueledby the Feds "monetary expansion" other words money printing ($3.5 trill). Without those money there would not be any sign of any recovery. Current interest rate is still almost at 0% for almost 8 years. There is no other tool for the Feds left but inflation. Most likely negative rates or/and they may resume money printing.