It seemed so plausible. Break through the zero lower bound and ta dah! A new scale of economic stimulus can be engineered.
And yet, as the likes of us, Frances Coppola and even Downfall Hitler have been warning for a number of years, this was always a silly presumption because negative carry creates an entirely different incentive structure to that of a positive carry world.
Notably, it encourages predation, monopolisation, hoarding and in some cases, even contraction as opposed to growth. Read more
From the FT’s Jamie Chisholm on Thursday:
Gold and the yen are surging to multimonth highs while stocks and the dollar are in sharp retreat after Federal Reserve chair Janet Yellen warned that global financial market turbulence could hurt US growth.
Yes indeed. But it’s also an entirely absurd and inefficient market reaction.
If you tell people you’re going to tax them just for the privilege of having them lend you their spare capital, those people are in turn supposed to treat you like an ungrateful entity and walk away to find more grateful recipients elsewhere or — at the very least — spend the tax differential on people or causes who might in the end benefit from the spending and show you some non-monetary gratitude even if they’re unlikely to ever pay the sum back directly. Read more
What drove the 2008 banking crisis were fears of capital insolvency.
What seems to be driving the 2016 bank stock sell-off is a re-evaluation of how equity markets account for the book value of financial institutions in a world of NNIM (negative net interest margins) and eurodollar outflows.
But also, we should think, the degree to which NNIM itself is influenced by the sound of a giant vacuum cleaner sucking petrodollars out of the non-US banking system, the commodity-credit feedback loop of hell and the general subpriming of commodities through the repo collateral markets.
To cut a long story short: if we’ve arrived at a point where commodity collateral is no longer considered safe, that’s one less safe asset in the system, and a helluva lot more pressure on the remaining safe assets (government bonds) to protect par value. Read more
UBS’s Paul Donovan offered some thoughts earlier this week on the unintended consequences of negative rate regimes, which — whilst interesting — stimulated a different thought in us related to data.
Here’s the comment, see if you think you know what we’re getting at…
Moving rates negative for some depositors and to zero for other depositors may create some real world distortions. If there is a greater incentive to hold money in physical form rather than electronic form, then the composition of narrow money (i.e. cash and cash substitutes) may alter. Rather than relying on electronic money, physical money will be used for everyday transactions. This is not entirely costless, as there is a security risk in storing cash under the mattress (historically the security risk was one of the key reasons for the creation of bank accounts in the first place).
Did you know there was a hidden credit crunch going on in the world economy as far into the post-GFC-crisis era as 2015?
UBS economist Paul Donovan dishes the details in a report on Tuesday, noting how the crunch related primarily to inter-company credit, the sort that companies use to finance inventory. The good news, says Donovan, is that smaller business finally seem to be willing to acquire inventory, suggesting the credit crunch may finally be concluding.
Quantifying the scale of the potential inventory turn-around isn’t going to be easy. As Donovan notes:
This chart shows the process at work after 2008. The NFIB survey showed a collapse in the desire of small businesses to hold inventory. Meanwhile their suppliers (large businesses represented in the ISM data) continued to expect an increase in demand as they viewed their customers’ inventory levels as inadequate by historical standards.
The NFIB and ISM surveys are not ideal measures, as sentiment surveys have a tendency to overreact to underlying fundamentals. However, the sub-headline indices of these details may be thought of as less liable to media influence and political bias.
Unfortunately, in spite of the overwhelming importance of inter-company credit as a source of finance, most economies fail to provide a high frequency, precise data series for this measure. There are occasional surveys (like the US National Association of Credit Managers) but these have a weak correlation what official data on inter-company credit is available – possibly a reflection of the poor sample size.
Regarding how low negative interest rates can go, Paul Krugman wrote a couple of weeks ago that:
When central banks push interest rates on government debt below zero, the effective lower bound is the return on cash held by people who would otherwise be holding that government debt — not people looking to expand their checking accounts. So the liquidity advantages of bank deposits over cash in a vault are pretty much irrelevant. It’s all about the cost of storage.
As Paul Krugman always likes to recount, strange things happen at the zero bound. Macroeconomics gets weird. Liquidity traps prevail. And a whole slew of paradoxes come into being.
And that’s largely because below the zero bound things get even stranger still.
What you think should happen, doesn’t, and what you think definitely won’t happen, does. Furthermore, negative interest rates don’t just kill off the traditional point of banking, they encourage bad incentives and dubious market practices for all purveyors of capital. Read more
About time we familiarise ourselves with a new three-letter acronym: NIM. It’s bank parlance for “net interest margin”. And all you need to know about NIM is that once you strip out all the other stuff banks do after lending, it’s probably the best measure we have of how profitable a bank’s core business is.
The problem these days is that a negative carry universe doesn’t sit well with NIM. Not only are you having to pay people to borrow from you, unless you’re particularly well funded or in the banking elite, you’re probably having to borrow at more than zero. So, unless you’re a bank that has a habit of err, creating false markets or artificial scarcities — which we know has been severely constrained in the new post-crisis regulatory climate — NIM compression is a bit of a big deal.
And small surprise, bankers are beginning to worry, especially now that negative rates are a Eurozone-wide thing. (FWIW FT Alphaville’s “negative carry” tag takes that concern back as far as 2012.) Read more
Kudos to Krugman for attempting to explain to Pimco’s Bill Gross that return on capital is not something that can be taken for granted.
His comments follow remarks from Gross that capitalism “needs carry” to survive. Read more
Gary Jenkins writing in Credit Matters this week gets to the heart of the matter when it comes to what investors should do with their money (our emphasis):
Is nowhere safe? The natural reaction to this is that fi nancing for banks should become more expensive. We are already seeing this reaction in the market to some degree. But what does this mean for a product like Cocos? How does an investor monitor the risk of conversion if the ECB could, on any given day, decide to withdraw liquidity unless the bank were to improve its capital position?
Remember the whipsawing days of 2008? The days when commodity prices couldn’t get crazier?
By now, everyone is familiar with the mantra that QE is [arghh!] money-printing and that a major unintended consequence could be a chronic and uncontrollable inflation. (One could call this the goldbug, Austrian, Republican case).
Less well known, perhaps, is the theory that QE could be just as unexpectedly deflationary — because long-term micro yields come to threaten a number of financial sectors outright, as well as general expectations of risk-free returns which lead to capital destructive feedback loops. Read more
FT Alphaville has presented its case on negative rates and zero deposit rates here and here (amongst other places).
What we believe is that rather than stimulating the lending market — and the economy along with it — such a rate policy could have a disastrous impact on collateral markets and money market funds, not to mention the net interest income of lending institutions. All of which could unleash a protracted deflationary spiral. Read more
A little update on what short-term rates are pricing in when it comes to BoE meetings this fall courtesy of ICAP’s Nick Middleton.
As he observes, something of a 25 bps cut definitely being eyed to some degree: Read more
Here’s an interesting factoid by way of Bartosz Pawlowski from BNP Paribas’ CEEMEA team — Eurozone yields aren’t the only ones being haunted by negativity.
As it turns out, euro-denominated non-eurozone debt is also treading perilously close to the zero mark. Read more
Okay. It’s true. We’ve become slightly obsessed with negative yields at FT Alphaville. Especially with regards to what they signify for the financial industry.
Though, for a long time we’ve felt very much alone with this obsession. Weirdly enough, nobody else has seemed too bothered about it. (Note, we even had to go to the ECB directly to ask Draghi what he thought about it.) Read more
Finding out that you are dealing with a terminal disease is never easy.
The natural reaction is to seek out a cure, no matter how bleak your chances. You will, for the most part, do almost anything to live. That includes changing your habits, your lifestyle, your friends, your profession or, for that matter, doing things you never previously considered doing. Whatever it takes to get just one more day of life. Read more
A while ago we observed that negative gold leasing rates were potentially signalling something awry with the Libor rate.
That judging by gold forwards, the Libor component of the gold lease rate calculation (Libor-GOFO = Lending rate) was coming in much lower than what might otherwise be expected. Read more
Low yields in the context of epic supply may baffle some people, but not UBS’s Chris Lupoli.
Lupoli, part of Global Macro Team, seems, if anything, to subscribe to our negative carry shift theory — the idea that a more permanent curve transformation may be under way. Read more
Here are some charts we knocked up (in our usual MS paint, so excuse the pixelation) to try and explain why the banking system’s biggest problem may lie in ‘negative carry’ — a phenomenon that would make investment-focused lending unprofitable, pushing the onus instead on predatory-profits extracted from economically destructive practices.
We begin with the following (click to expand): Read more
This is a follow-up to our post on “base money confusion“, which incorporates some of the ideas we’ve raised in our “beyond scarcity” series.
Let’s assume a few truths (we’re sure they’ll be up for debate, but here goes anyway): Read more