Is anyone betting on negative interest rates?

[njhowie]

Quote:

Originally Posted by pb4uski If bonds are negative, then people will just put their money in FDIC insured checking and savings accounts even if they pay a paltry 0.01% then it would be better than a bond yield.

That's what most folks will do. However, it would not be optimal if interest rates are going "even lower" (more negative).

[Sunset]

Quote:

Originally Posted by pb4uski I'm not sure how negative interest rates would work for individuals in the US. If bonds are negative, then people will just put their money in FDIC insured checking and savings accounts even if they pay a paltry 0.01% then it would be better than a bond yield. It seems to me that in order for it to work that bank checking and savings accounts would have to be negative as well... and that would be so unpopular that I don't see that happening.... so I'm not sure how it would work. Assuming that bank savings and checking accounts are not also negative, I would take my fixed income money and split it amoung FDIC insured accounts. The other thing is that inflation is the base for the composition of interest rates in finance theory, so does that mean that we would also have deflation?

I'm thinking I will borrow $200 Million Billion,
bury it and repay the $198 -> $199 Billion at the end of a year.

[njhowie]

Quote:

Originally Posted by Sunset I'm thinking I will borrow $200 Million Billion, bury it and repay the $198 -> $199 Billion at the end of a year.

And what collateral will you be putting up to secure the $200 billion?

[Red Badger]

Quote:

Originally Posted by jim584672 To me it makes no sense. Why lend money and have to pay for the privilege, also take the risk of default, when you could literally put cash in the mattress and do better?

Exactly. Lending to the kids come to mind.

[jazz4cash]

I agree negative rates are a bad idea plus they don’t work. The market rather than the Fed might push rates below 0. I recently realized the cashback credit cards and even cards that don’t charge interest from the transaction posting date are like negative rates in our favor.

[Montecfo]

The Fed could lower rates below zero. It could happen, whether it is considered "good policy" by you and me, or not. Market action could do the same.

I have been thinking about this and, like the OP, I think US rates could go negative.

If you think this will happen it will obviously increase the value of bonds paying a positive coupon. The longer the remaining term of the bond, the more leveraged it will be to lower rates.

But it would also tend to increase equity values since it reduces the rates used to discount future cash flows.

So for financial.assets I tend to think it would be a positive, if such rates are prevalent in other countries. If not then you have to weight capital flight/ currency weakness into to math.

There are a few moving parts here.

[Dtail]

Quote:

Originally Posted by Montecfo The Fed could lower rates below zero. It could happen, whether it is considered "good policy" by you and me, or not. I have been thinking about this and, like the OP, I think US rates could go negative. If you think this will happen it will obviously increase the value of bonds paying a positive coupon. The longer the remaining term of the bond, the more leveraged it will be to lower rates. But it would also tend to increase equity values since it reduces the rates used to discount future cash flows. So for financial.assets I tend to think it would be a positive, if such rates are prevalent in other countries. If not then you have to weight capital flight/ currency weakness into to math. There are a few moving parts here.

Yes could be, but then the Fed has effectively used up that side of management of economy issues, so what comes next?

[tenant13]

Quote:

Originally Posted by Dtail Yes could be, but then the Fed has effectively used up that side of management of economy issues, so what comes next?

That's another good question. If we were to look back at other central banks going nuts with printing machines (say, Weimar Republic), the logical step would be hyperinflation. But US is in a unique position of controlling world's reserve currency right now. Most debt is denominated in US dollars so there's a demand for our currency out there. With our number one export product: the dollar, we are able to export the inflation and pretend there is none domestically (tell that to health insurance policy buyers or parents with college age children though - inflation is a personal experience imo).

That's what I think was happening after 2008 crisis - we printed tons of money, US inflation stayed more or less in check but the rest of the world started creaking (look at Greece, Chile, Argentina, Venezuela or Lebanon - I bet I missed a bunch). I think that as long as dollar remains in power we can consider ourselves lucky and sleep well. Probably for a long while. We may all be dead by the time dollar will become irrelevant. But who knows.... with China's digital currency on the horizon things may change faster than we'd like.

None of this bodes well for bonds. Either inflation will destroy their value or Fed will try to raise interest rates in an effort to control inflation and that in effect will destroy their value. Or the world will lose trust in our currency. After all it is backed by the US economy and you'd have to be very optimistic to see it as healthy.

So as I see it bonds are becoming a speculative asset: buy now, bet on negative rates, sell. Alternatively, if you like bonds for their security you could keep buying short term treasury bills (1-6months) or invest in Treasury Inflation-Protected Securities. I personally do like TIPS as an alternative to cash but don't trust Consumer Price Index so am a bit skeptical about their actual value.

[Sunset]

Quote:

Originally Posted by njhowie And what collateral will you be putting up to secure the $200 billion?

That could be an issue, could you co-sign for me

[Montecfo]

I think you will not have high inflation without big in increases in demand. Now if we are effective at re-shoring some.of the China based industries you could get some inflation, but I do not think it will be high without big increases in demand.

The larger and scarier risk is deflation. Must avoid.

As far as what happens next, well, the economy begins growing at a sufficiently rapid rate that interest rates rise.

But I thought this was an investment thread. Have we veered into monetary policy?

[tenant13]

Quote:

Originally Posted by Montecfo I think you will not have high inflation without big in increases in demand. Now if we are effective at re-shoring some.of the China based industries you could get some inflation, but I do not think it will be high without big increases in demand. The larger and scarier risk is deflation. Must avoid. As far as what happens next, well, the economy begins growing at a sufficiently rapid rate that interest rates rise. But I thought this was an investment thread. Have we veered into monetary policy?

I'm not sure we can separate the two. Without the current monetary policy, our investments strategies would be different - I wouldn't think of speculating with bonds.

And I agree that for as long as there's this out of control unemployment we are facing deflation - there isn't much demand for anything. I'm thinking of what happens after.

[Dtail]

Quote:

Originally Posted by tenant13 I personally do like TIPS as an alternative to cash but don't trust Consumer Price Index so am a bit skeptical about their actual value.

The CPI is also the aspect of TIPS I don't like. The calculation of CPI can be effectively be manipulated downward to lower values if inflation starts rising much higher, in order to not pay larger increases in SS payments.

[tenant13]

Quote:

Originally Posted by Dtail The CPI is also the aspect of TIPS I don't like. The calculation of CPI can be effectively be manipulated downward to lower values if inflation starts rising much higher, in order to not pay larger increases in SS payments.

Manipulation is one thing and our personal expense structure another. I don't have kids so I have no clue about raising college costs (or anything kids related). In normal circumstances I travel a lot so I'm sensitive to all the travel related expenses. I think healthcare costs affect us differently. Etc. etc.... Inflation is not just a number that some gov agency announces. Having said that TIPS seem like a viable option for a diversified portfolio.

[njhowie]

Quote:

Originally Posted by Dtail The CPI is also the aspect of TIPS I don't like. The calculation of CPI can be effectively be manipulated downward to lower values if inflation starts rising much higher, in order to not pay larger increases in SS payments.

This is a valid concern. There is moral hazard on the part of the government, as it's not only SS payments, but all entitlements which have COLA increases built in.

However, as I'm deciding where to park cash inside DW's 401k, I'm looking at a money market fund on one hand below 0.05% and then VAIPX on the other. We're now adding to VAIPX.

[samm]

Agree on economic outlook. Easy money boosts markets short term but only productive investments drive GDP growth.

Vanguard Long-Term Tax-Exempt Fund Admiral Shares (VWLUX) yields 1.83% today, which is equivalent to 2.61% for a taxable bond (30% tax rate assumption).

So, rates have room to fall.

[OldShooter]

Quote:

Originally Posted by Dtail The CPI is also the aspect of TIPS I don't like. The calculation of CPI can be effectively be manipulated downward to lower values if inflation starts rising much higher, in order to not pay larger increases in SS payments.

OK, fine. Can you bird-dog for me a security that has all the aspects of TIPS but uses a "better" inflation adjuster? I'm a buyer.

Better is the enemy of good.

[samm]

So, if CPI is under-stated by 1%, the entire Treasury yield curve is already priced to deliver negative real yields.

Quote:

Originally Posted by Dtail The calculation of CPI can be effectively be manipulated downward to lower values if inflation starts rising much higher, in order to not pay larger increases in SS payments.

https://www.investopedia.com/article...priceindex.asp

The Controversy
Originally, the CPI was determined by comparing the price of a fixed basket of goods and services spanning two different periods. In this case, the CPI was a cost of goods index (COGI). However, over time, the U.S. Congress embraced the view that the CPI should reflect changes in the cost to maintain a constant standard of living.1 Consequently, the CPI has evolved into a cost of living index (COLI).

Over the years, the methodology used to calculate the CPI has undergone numerous revisions. According to the BLS, the changes removed biases that caused the CPI to overstate the inflation rate. The new methodology takes into account changes in the quality of goods and substitution. Substitution, the change in purchases by consumers in response to price changes, changes the relative weighting of the goods in the basket.2 The overall result tends to be a lower CPI. However, critics view the methodological changes and the switch from a COGI to a COLI as a purposeful manipulation that allows the U.S. government to report a lower CPI.

[calmloki]

Quote:

Originally Posted by samm So, if CPI is under-stated by 1%, the entire Treasury yield curve is already priced to deliver negative real yields. https://www.investopedia.com/article...priceindex.asp The Controversy Originally, the CPI was determined by comparing the price of a fixed basket of goods and services spanning two different periods. In this case, the CPI was a cost of goods index (COGI). However, over time, the U.S. Congress embraced the view that the CPI should reflect changes in the cost to maintain a constant standard of living.1 Consequently, the CPI has evolved into a cost of living index (COLI). Over the years, the methodology used to calculate the CPI has undergone numerous revisions. According to the BLS, the changes removed biases that caused the CPI to overstate the inflation rate. The new methodology takes into account changes in the quality of goods and substitution. Substitution, the change in purchases by consumers in response to price changes, changes the relative weighting of the goods in the basket.2 The overall result tends to be a lower CPI. However, critics view the methodological changes and the switch from a COGI to a COLI as a purposeful manipulation that allows the U.S. government to report a lower CPI.

Never have understood how, just because I'm responding to $10/# steak by buying $5/# hamburger - substituting - that my cost of living has remained the same. Sure, still alive and eating food and maybe the food budget has remained the same but it sure feels like inflation has taken place. Guess COGI feels more right/honest to me.

[samm]

Quote:

Originally Posted by calmloki Never have understood how, just because I'm responding to $10/# steak by buying $5/# hamburger - substituting - that my cost of living has remained the same. Sure, still alive and eating food and maybe the food budget has remained the same but it sure feels like inflation has taken place. Guess COGI feels more right/honest to me.

You are correct. I worked at a leading actuarial firm in 1990s and was very familiar with the CPI debate. In brief, large employers wanted lower CPI because wages track CPI. Some federal departments also wanted lower CPI to lower projected SS payments for baby boomers. The consumer was not included in these discussions and outsiders were bamboozled with "hedonic adjustment factors".

From Wikipedia
The Boskin Commission, formally called the "Advisory Commission to Study the Consumer Price Index", was appointed by the United States Senate in 1995 to study possible bias in the computation of the Consumer Price Index (CPI), which is used to measure inflation in the United States. Its final report, titled "Toward A More Accurate Measure Of The Cost Of Living" and issued on December 4, 1996, concluded that the CPI overstated inflation by about 1.1 percentage points per year in 1996 and about 1.3 percentage points prior to 1996.

The report was important because inflation, as calculated by the Bureau of Labor Statistics, is used to index the annual payment increases in Social Security and other retirement and compensation programs. This implied that the federal budget had increased by more than it should have, and that projections of future budget deficits were too large. The original report calculated that the overstatement of inflation would add $148 billion to the deficit and $691 billion to the national debt by 2006.

The report highlighted four sources of possible bias:

Substitution bias occurs because a fixed market basket fails to reflect the fact that consumers substitute relatively less for more expensive goods when relative prices change.
Outlet substitution bias occurs when shifts to lower price outlets are not properly handled.
Quality change bias occurs when improvements in the quality of products, such as greater energy efficiency or less need for repair, are measured inaccurately or not at all.
New product bias occurs when new products are not introduced in the market basket, or included only with a long lag.

Michael Boskin is a registered republican and a Professor of Economics and senior Fellow at Stanford University's Hoover Institution.

[Dtail]

Quote:

Originally Posted by OldShooter OK, fine. Can you bird-dog for me a security that has all the aspects of TIPS but uses a "better" inflation adjuster? I'm a buyer. Better is the enemy of good.

Don't have that answer. I know you are a big fan of TIPS. I am not.

Question: Has Social Security payments in the last 20 years kept up with true inflation?

The CPI formula has been changed to effectively not recognize the true costs of older Americans.
My comments are more CPI based, not TIPS value based.