The rise and rise of negative interest-rates

The modern era has brought something that has been in motion all my career, although there have been spells which did not feel like that. I am discussing bond yields which have been in a secular decline since the 1980s. Regular readers will be aware that back when I was new to this arena I asked Legal and General why they were buying a UK Gilt that yielded 15%? Younger readers please feel free to delete such a number from your memories if it is all too much. But there is another shift as back then the benchmark was 20 years and not 10. However you look at it from that perspective a world in which both the 2 and 5 year UK bond or Gilt yields were around -0.13% would have been considered impossible it not unpossible.

Germany

These have been the leaders of the pack in terms of negative bond yields. Last week Germany sold a benchmark 10 year bond with no coupon at all. We should take a moment to consider this as a bond is in theory something with a yield or coupon so as it does not have one we are merely left with money being borrowed and then repaid. Except there was a catch there too as not all of it will be repaid. The price paid was 105.13 on average and you will only get 100 back. Or if you prefer a negative yield of the order of 0.5% per year.

This year has brought something that in the past would have ended the situation as this.

The German Federal Government intends to issue fixed income Government securities with an aggregate volume of € 210 billion in 2020 to finance
the Federal Government budget and its special funds.

Became this.

The auction volume in the first two quarters of the current year amounted to € 97 billion for nominal capital market instruments (planned at the beginning of the year: € 78 billion) and € 87.5 billion for money market instruments (planned at the beginning of the year: € 31 billion)…….Due to the adjustments, the third quarter auction volume for nominal capital market instruments will total € 74 billion (planned at the beginning of the year: € 41 billion).

As you can see there were considerably more bonds on offer but it has made little or no difference to investors willingness to accept a maturity loss or negative yield. Oh and maybe even more bonds are on the way.

In non-regular reopenings on 1 and 16 April, a total amount of € 142 billion of already existing Federal securities was issued directly into the Federal government’s own holdings. These transactions created the possibility to react flexibly to short-term liquidity requirements.

So we learn that the previous reality that Germany was benefiting from its austere approach to public finances was not much of an influence. Previously it has been running a fiscal surplus and repaying debt.

Switzerland

The benchmark yield is very similar here as the 10 year yield is -0.49%. There are many similarities in the situation between Germany and Switzerland but one crucial difference which is that Switzerland has its own currency. The Swiss Franc remains very strong in spite of an interest-rate of -0.75% that has begun to look ever more permanent which is an irony as the 1.20 exchange-rate barrier with the Euro was supposed to be that. The reality is that the exchange-rate over five years after the abandonment of that is stronger at just below 1.08.

So a factor in what we might call early mover status is a strong currency. This also includes the Euro to some extent as we note ECB President Lagarde was on the wires over the weekend.

ECB Lagarde Says Euro Gains Have Blunted Stimulus Boost to Inflation … BBG

This allows us to bring in Japan as well as the Yen has remained strong in spite of all the bond buying of the Bank of Japan.

Safe Haven

The ECB issued a working paper on this subject in January.

There is growing academic and policy interest in so called “safe assets”, that is assets that have stable nominal payoffs, are highly liquid and carry minimal credit risk.

Notice the two swerves which are the use of “stable nominal payoffs” and “minimal credit risk”. The latter is especially noticeable for a place like the ECB which insisted there was no credit risk for Greece, which was true for the ECB but not everyone else.

Anyway it continues.

After the global financial crisis, the demand for safe assets has increased well beyond its supply, leading to an increase in the convenience yield and therefore to the interest that these assets pay. High demand for safe assets has important macroeconomic consequences. The equilibrium safe real interest rate may in fact decline well below zero.

They also note a feature we have been looking at for the best part of a decade now.

In this situation, one of the adjustment mechanisms is the appreciation of the currency of issuance of the safe asset, the so called paradox of the reserve currency.

Quantitative Easing

The problem for the theory above is that the central banks who love to push such theories ( as it absolves them of blame) are of course chomping on safe assets like they are their favourite sweets. Indeed there is a new entrant only this morning, or more accurately an expansion from an existing player.

The Executive Board of the Riksbank has decided to initiate purchases of corporate bonds in the week beginning 14 September 2020. The purchases will keep
companies’ funding costs down and reinforce the Riksbank’s capacity to act if the credit supply to companies were to deteriorate further as a result of the corona pandemic. On 30 June 2020, the Executive Board decided that, within its programme for bond purchases, the Riksbank would offer to purchase corporate bonds to a
nominal amount of SEK 10 billion between 1 September 2020 and 30 June 2021.

There are all sorts of issues with that but for today’s purpose it is simply that the push towards negative interest-rates will be added to. Or more specifically it will increasingly spread to higher risk assets. We can be sure however that should some of these implode it will be nobody’s fault as it could not possibly have been predicted.

Meanwhile ordinary purchases around the world continue including in my home country as the Bank of England buys another £1.45 billion of UK bonds or Gilts.

Comment

There are other factors in play. The first is that we need to try to look beyond the present situation as we note this from The Market Ear.

the feedback loop…”the more governments borrow, the less it seems to cost – giving rise to calls for still more borrowing and spending”. ( Citibank)

That misses out the scale of all the central bank buying which has been enormous and gets even larger if we factor in expected purchases. The US Federal Reserve is buying US $80 billion per month of US Treasuries but with its announcement of average inflation targeting seems likely to buy many more

Also the same Market Ear piece notes this.

The scalability of modern technology means that stimulus is going into asset price inflation, not CPI

Just no. What it means is that consumer inflation measures have been manipulated to avoid showing inflation in certain areas. Thus via Goodhart’s Law and/or the Lucas Critique we get economic policy based on boosting prices in these areas and claiming they are Wealth Effects when for many they are inflation.

We get another shift because if we introduce the issue of capital we see that up to know bond holders will not care much about negative yields as they have been having quite a party. Prices have soared beyond many’s wildest dreams. The rub as Shakespeare would put it is that going forwards we face existing high prices and low or negative yields. It used to be the job of central banks to take the punch bowl away when the party gets going but these days they pour more alcohol in the bowl.

Meanwhile from Friday.

UK SELLS 6-MONTH TREASURY BILL WITH NEGATIVE YIELD AT TENDER, FIRST TIME 6-MONTH BILL SOLD AT NEGATIVE YIELD ( @fiquant )

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16 thoughts on “The rise and rise of negative interest-rates

  1. Have been saying negative interest rates on the cards for months now, its more than just a gut instinct all data suggests this will happen.

    Difficult to say what the impact will be as most people on fixed rates but it may have a short term on house prices.

    In fact since the pandemic houses with gardens and “suburbia” already having an impact as this from SKY news this morning:

    “07:48

    Renters paying more to move to bigger homes in the suburbs post-lockdown

    Tenants in England are increasingly opting to upsize to bigger properties in quieter areas as a result of the financial fallout from the coronavirus crisis, a survey has found.

    Between May and August, around a third (34%) of tenants moving home added at least one extra bedroom to their property, marking a significant increase on the 25% who did so in the first three months of the year, Hamptons International said.

    Demand for renting has generally edged up in small towns and suburbs while it has decreased in cities, the survey found.

    Upsizing does comes at a cost though, with tenants who do so typically paying £149 per month more in rent.

    The trend was most prominent in the South East, with 47% of people moving post-lockdown spending an extra £266 a month on average.

    Nearly two thirds of London renters upsizing have chosen to leave the capital, helping to ease the burden of having a bigger home. ”

    How long this is going to last or pan out is difficult to quantify, there is a two way pull at the moment , one way due to low interest rates and GOV help the other way rising unemployment and fear.

    Fear will win in the end and house prices fall in some areas like cities imo but some areas will see less of a fall or market maintain more stability. All depends how the coronavirus pans out form here, how high unemployment rises and whether or not things will deteriorate longer term. All of which is not foreseeable.

    • “All of which is not foreseeable.”

      I’d state that if the Western economies are not back near their pre-“pandemic” levels by Christmas then collapse will happen ( -10% GDP down from January 2020)

      extrem?

      Well a little birdie told me that a certain German airline borrowed 9 billion and by xmas they’d have 3 billion left – at which point layoffs and restructuring will eat the remaining 3 billion.

      As the reader will have guessed , poor people don’t buy houses and serivices , thus a spirial down will accelerate……

      Even BTL will find it hard to get anyone to rent .

      I don’t think printing money will help .

      Could be I’m wrong but with talk of another hard lock down ……..

      Forbin

    • People want out of packed cities; I posted this the other day.
      Ironically, the stack-&-pack Agenda 2030 crates being built by tptb are going to be avoided like the plague because of tptb’s plannedemic.

  2. Hello Shaun,

    bond yeald fall and bang goes my pension pot – -3% ? going to be more like -5%

    so cash them in and go on holiday ……. nope locked down ( I’m high risk apparently )

    only landlords are profiting from this – ie asset owners

    how do you run a Service based economy with strangled services ?

    all virtual ? could be, one of Asimov’s visions……. to be seen with another human , yurk!

    Forbin

    • forbin

      “how do you run a Service based economy with strangled services ?2

      You cannot and to make matters worse the Chinese avoiding the UK and spending their money at home.

      The GOV need to rebalance the economy away from retail and services but that takes time.

      After the war there was a massive rebuilding which helped the construction industry and for a time things were improving before inflation hit and joe blogs started to strike then we saw the manufacturing move offshore.

      I think there were many mistakes made with successive governments, I didn’t agree with 24 hour drinking and relaxation of gambling laws.

      We need to get some of our manufacturing back which with new technology isn’t as labor intensive.

      There is a lot to do and difficult under the present economic and pandemic problems worldwide now.

      Landlords may have been profiting the last few years, but if the GOV don’t get a grip massive falls in property will come.

      If you look abroad people are moving out of Los Angeles in decent areas because the homeless are living in tents outside decent areas, and that could happen here as well.

      Idle hands increase crime so the GOV has to get the unemployment figures down whatever it takes and the rich have to see tax hikes.

  3. As Shaun has mentioned, the three central banks above just cannot weaken their currencies, even with unlimited QE and ever more negative rates, their currencies just keep getting stronger and stronger, contrast that with sterling and the Bank of England – when they imitate their fellow bankers and do the same, sterling drops like a stone, add in the proposed departure without a deal and the falls become precipitous, as if us leaving only affects us negatively, the EU are either left untouched or better off.
    Quite simply as I have shown here over the last couple of years, it doesn’t matter what the EU or the ECB do, the euro along with the Yen remains one of the strongest currencies in the world, despite all the rhetoric from so called experts over the decades of its demise and their predictions of the collapse of the EU and the end of the euro, it is getting stronger and stronger.Sterling is now banging on the trendline I warned about many times before on here, August last year at 0.93 and again in March this year, now it is at around 0.9240, I may be wrong, but this time I think it is going to blast through it. Since its launch on 1st Jan 1999 the euro is up 33% against sterling

    • The euro strength is principally from German mercantile policy and its exports. these are under real threat through their misguided ‘green’ energy policies and their apparent belief their vehicle manufactures can slug it out with the Chinese in the EV markets. If this goes wrong, as I personally think it will, it could have a devastating effect of the Euro. GBP unfortunately is a price taker not setter. UK’s core competencies of guns, drugs and money might fly again in a new trans-polar world, as a ‘new’ privateer nation. Skull and crossbones anyone?

      • Jim, I will add your name to the list of people predicting the end of the Eurozone and the euro,the EZ and the euro are being backed by the very people trying to destroy the western world as we know it – globalists if you like and they will not allow ANYTHING to stop its progress,the entire continent of Europe will eventually be under their control, so whether the German car industry survives or is destroyed by EV’s doesn’t matter, Italian and Spanish banks totally insolvent? not a problem, Greece’s basket case economy? rates going more negative? the euro just gets stronger and stronger, if the euro’s strength helps kill our economy to the point where we have to rejoin as an impoverished basket case like some eastern european state begging to join for the grants then that is what will happen,

  4. Shaun, stupid question for you. The men with the enormous brains who are saying we should be getting deeper and deeper into this, indeed are putting their Central Bank’s position where their mouth is….do any of them say quite how they plan to get us out of it at some ill-defined point in the future? Unwinding in a way that brings bond prices way down again seems an inevitable part of interest rates going back up, but I dread to think how many people and institutions would be burned by that. Perhaps too many and too badly to make it possible – but then thinking about how hard it would be to get out again seems an essential component of deciding whether we’ve gone too far already or not far enough yet, so presumably somebody’s been thinking about this? Or have they?

    • ” Or have they?”

      er, no

      ( so long as their pesions are protected)

      more interested in the sweet trolly I think

      “C” melbourne.intercontinental.

      Yummy!

    • You are crediting them with far more intelligence than they possess, to anyone who has been following them and their responses to the failing economy, it has become clear to everyone that they are making it up as they go along, they are responding to moves in the credit, bond and stock markets instead of forming monetary policy to influence them, and consequently, they haven’t a clue how to get us out, they will destroy everyone’s pensions and savings in order to try and secure their corrupt system.I even believe they are prepared to go as far as destroying the banks – yes the precious! Think of them as the F.A. in charge of clubs(the banks), if the clubs all go bust new ones can be created and the F.A. will still be in charge of them and the game, if they would do that, imagine what they would be prepared to do to your job, savings and pension.

  5. Shaun,

    With so many joining the bandwagon on negative yields and I noticed you mentioning the US treasury 6 month negative, does this not suggest that the so called “Masters of the Universe” think global assets are way overvalued and due for a crash ?

    Also if that is the thinking what would be the consequences on inflation, would the world be in for a period of deflation as assets collapsed?

    I am guessing there would be too many variables to give a simple or no?

    It seems to me like we are in a new world of economics and I don’t think the bankers and governments really know the answer to all this just like they don’t know how long the corona-19 pandemic will last for.

    • Hi Peter

      The establishment are trying to ramp asset prices ( be it bonds, equity or property) and in a way the most honest is The Donald.

      When a period of asset price falls is looked at, it so often gets forgotten that it makes them more affordable for many and we can start again. The problem with not letting at least some fall is that we end up with so many Zombies……

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