Will the spread of negative interest rates create a new “Carry Trade?”

One of the features of the post credit crunch era is the way that we see examples of what is in effect a bi-polar world. Rather than a range of possibilities and indeed probabilities we see examples of virtually straight yes or no alternatives. This to my mind is becoming illustrated more and more by the behaviour of interest rates and bond yields in different countries. This has given us a situation where some have to pay ever higher interest rates on borrowing but others may find themselves receiving negative interest rates on their savings. So they may save 100 and get back 99 in a year’s time.

The Banks and a new Carry Trade

There are risks here for them as I will be comparing different countries in today’s article but the new world into which we are advancing offers plenty of opportunity to profit. Or at least what the finance sector calls a profit.Loaning at high rates in one country and getting the money at negative interest-rates in another as in being paid to take the money looks like a bankers dream does it not? There is an exchange-rate risk but the Euro concept and its consequences have removed some of that at least for now. For example the Swiss National Bank has promised to take all the Euros  you can sell it at an exchange rate of 1.20 versus the Swiss Franc.

This type of event often relies on official intervention to make it work as you need something outside of ordinary behaviour -who wants to give away money?- but at times other priorities such as the political will of the Euro establishment take precedence and create an anomaly.

There is a strong possibility that a type of carry trade is in evidence again and for  the financial sector I would imagine it is very attractive. If it works you make large interest-rate profits on the gains and if it does not (for example the currency risk) then you hand your bank to your friendly local group of taxpayers. Probably along with phrases like “unexpected” and “couldn’t have been foreseen”. As ever why highly paid experts could not have foreseen what they were supposed to be experts in will remain a mystery.

Negative interest-rates are spreading

If we look at official interest-rates then we have seen examples of this develop in 2012. For example in Switzerland the two-year government bond yield first went negative back in early April and is -0.16% today. German yields have also gone negative at times although right now the only one actually negative is her three month one. Back in July the Danish central bank found itself issuing some of its certificates of deposits or CDs at an interest rate of -0.2%.

There are a lot of consequences from negative interest-rates but let me outline one issue by quoting from a Financial Times article from August 23rd.

Bank executives, as well as central bankers, are clear that lenders have to increase their loan prices to compensate for the loss, as they are unable to impose negative rates on customers.

Ah yes, so lower interest-rates officially mean higher ones for borrowers do they? Let me tuck that into my financial lexicon. Indeed Thomas Kressin of PIMCO (the world’s largest bond fund) described such thoughts like this.

It is almost quantum physics

It is a shame that Gemma Godfrey left Mindful Money as being a Quantum Physicist she might have offered some insight into such waffle!

However it is not turning out like that

Here are some news excerpts from Bloomberg News which follow on from the link I posted yesterday.

State Street will apply a negative interest rate of 0.75 percent annually to (Danish) krone deposits starting Nov. 1, with a separate charge for (Swiss) francs, according to a note to clients last week.

BNY Mellon started charging for krone deposits last month, a person with knowledge of the matter said

Royal Bank of Canada is imposing negative interest rates on some customers who hold Danish kroner and Swiss francs

It did not take long for them to change their mind about passing the costs on did it? Interestingly this is happening when you might think that the pressure is lower on the Swiss Franc and the Danish Krone due to Mario Draghi’s efforts at the European Central Bank. For example the Swiss Franc to Euro exchange rate has over the past couple of weeks moved from the 1.20 cap to the giddy heights/lows of 1.21. Not far but a move nonetheless.

So we see that the negative interest-rates for customers which we were being told would not happen less than two months ago is beginning already. At this point the move is mostly indirect as apart from wealthy private-clients this move will affect investment and pension funds mainly. But, how long do you think it will be before this spreads more widely and affects individual savers in these countries directly?

Higher interest rates can be found elsewhere

On the other side of the Euro crisis we do see countries at the other end of this bi-polar world with much higher interest-rates. Tucked away for example in the Standard and Poors downgrade of Spain last night to one level above “junk” status, or if you consider that to be a four letter word then please substitute sub-investment grade for it, was this.

While lending rates have declined in recent months for blue chip corporate borrowers, small and medium sized enterprises (which employ 76% of the national workforce) are paying average interest rates of 6.6% as of August (TEDR, Tipo effective definicion restringida) on borrowings up to five years, versus 4.8% in 2009.

I took note of this and you can see how this example got me thinking. If we look back to the “carry trade” of the last decade we saw how the financial sector latches onto such discrepancies. Now we see the ability to borrow at negative interest-rates developing whilst you can lend out at higher ones and do so with  guarantees from two central banks that you have no currency risk. If it all goes wrong you depart with the bonuses you had made blaming the uncertain economic climate created by the failure of the Danish and Swiss central banks to do as they promised. In the uncertain melee of such a situation I expect them to get away with it. After all they have got away with weaker excuses so far.

The Spanish interest-rates I quoted above were an example but I am sure we can find plenty of other examples in Spain and Italy to soak up the money.

Comment

I thought that today I would look ahead to something which may not reach the mainstream media for months or years. But negative interest-rates and yields will create anomalies which the finance sector will exploit. I have given the example of banks but I am using them as a generic term as I would expect the shadow banking system to be a major player too here. Also I am discussing what I expect to happen as well as what I am sure some are already doing but keeping quiet about.

A warning for savers

This concept poses quite a few questions. I have asked before what those reading this with savings would do if offered negative interest-rates? I would like to ask readers again for their thoughts.

This matters because peering into my crystal ball I think that it is becoming increasingly likely that we will see negative interest-rates spread. As we stand I would expect the European Central Bank to move first and would not be surprised to see the US Federal Reserve follow. As to my own country I have been surprised that the Bank of England has not moved nearer to this so if it comes from them it is likely to be in response to a crisis, of which there seems to be no end in sight.

I will in subsequent posts develop this theme and my views on its consequences. For those looking to see how my thoughts in this area have developed here is a link to them from September 2nd 2011.

http://www.mindfulmoney.co.uk/wp/shaun-richards/negative-interest-rates-have-failed-to-halt-the-rise-of-the-swiss-franc-but-will-they-spread-to-us-anyway/