Is anyone betting on negative interest rates?

[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]

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]

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]

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]

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]

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]

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]

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]

Yes. Interest Rates Can Go Lower

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]

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.

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/articles/07/consumerpriceindex.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]

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/articles/07/consumerpriceindex.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]

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]

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.

 

[Montecfo]

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.

I am not an economist but those areas of bias appear to be real concerns.

Quality of goods is a big item. You may be paying more for something but it may be better, cheaper or both (like cell phones and service). Autos last longer and have more safely features. Lots of examples.

Obviously CPI does not capture individual circumstances. Everyone has a personal CPI. I have not attempted to calculate mine. But I recall that I used to think that retired folks would tend to have a lower personal CPI, since housing costs, a large part of most budgets, are relatively fixed.

Prices overall have rise slowly and steadily for the most part. But they do rise for sure, and some more than others.

 

[Chuckanut]

The CPI formula has been changed to effectively not recognize the true costs of older Americans.

I would hope the CPI was never designed to recognize the costs of just one group of Americans.

 

[Mulligan]

I am not an economist but those areas of bias appear to be real concerns.

Quality of goods is a big item. You may be paying more for something but it may be better, cheaper or both (like cell phones and service). Autos last longer and have more safely features. Lots of examples.

Obviously CPI does not capture individual circumstances. Everyone has a personal CPI. I have not attempted to calculate mine. But I recall that I used to think that retired folks would tend to have a lower personal CPI, since housing costs, a large part of most budgets, are relatively fixed.

Prices overall have rise slowly and steadily for the most part. But they do rise for sure, and some more than others.

I agree inflation is very individual. I have been retired 10 years. If health insurance wasnt needed, inflation would have been so minuscule for me, it wouldnt even be worth discussing.

 

[OldShooter]

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.

No, I did not make my point very directly. It's just fine to grouse about the CPI, the gummint cooking the inflation books, etc. but it's the only game in town. I agree completely; hypothetically there are better inflation measures but if you have no access to instruments based on any better measure then there is little point in grousing about TIPS being based on the CPI.

 

[Dtail]

I would hope the CPI was never designed to recognize the costs of just one group of Americans.

True, but logically if Social Security is only given to folks 62 and over and many folks outside of this forum depend heavily on it, there could be some attempt to include on a relative basis more of costs which affect this segment of the population. i.e. a separate CPI calculator for this segment.

 

[OldShooter]

True, but logically if Social Security is only given to folks 62 and over and many folks outside of this forum depend heavily on it, there could be some attempt to include on a relative basis more of costs which affect this segment of the population. i.e. a separate CPI calculator for this segment.

I have read discussion of that. IIRC the idea was that a geezer CPI would rise less than the standard CPI because of the things that we geezers buy and don't buy. I believe the argument was that to make this adjustment to SS would be fair and BTW would reduce long-term SS costs.

I don't worry about this kind of thing very much because it's like the changing glaciers -- nothing I can do about it. Whatever happens will happen whether I expend energy being spun up about it or not.

 

[samm]

if Social Security is only given to folks 62 and over and many folks outside of this forum depend heavily on it, there could be some attempt to include on a relative basis more of costs which affect this segment of the population. i.e. a separate CPI calculator for this segment.

There has been a lot of discussion of the Senior CPI concept.

This argues that the current SS COLA is lower than actual cost increases.
https://www.ncpssm.org/documents/so...option-for-calculating-social-security-colas/

The Dept Of Labor has studied idea of CPI-Elderly called CPI-E.
https://www.bls.gov/opub/ted/2012/ted_20120302.htm

 

[drcha]

How would one make such a bet and then make money from the bet?

Buy 30-year Treasuries.

 

[wildbilly]

My understanding of negative interest rates means if you have a bunch of cash sitting around like me, then the bank takes away money from you. That is, you pay the bank for the privilege of holding your money. The idea is that you start investing/spending the money instead and thus stimulating the economy.

This is a big part of why cryptocurrencies were born. I'm not sure that solves the problem though as it's not like cash buried in the ground.

I'm certainly not going to put money into the stock market as it's crazily over stuffed though it keeps on climbing (due to easy money and ).

 

[tenant13]

I'm certainly not going to put money into the stock market as it's crazily over stuffed though it keeps on climbing (due to easy money and ).

The market is obviously inflated but that's not good enough reason to stay away from it. Your pile of cash just sits there and loses value. In my case it's even worse as the cash is in IRA - I can't just spend it.