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General Category => General Discussion => Topic started by: Viking on June 28, 2019, 04:33:54 PM

Title: Negative interest rates take investors into surreal territory
Post by: Viking on June 28, 2019, 04:33:54 PM
Is this where North America is headed. Do we care if negative rates are here to stay? How does this change the investment process?

https://www.ft.com/content/09360f2e-98b4-11e9-9573-ee5cbb98ed36?ftcamp=traffic/partner/feed_headline/us_yahoo/auddev&yptr=yahoo

Beginning of article: “This summer, Germany’s housing market has turned into Alice in Wonderland: the yield on five-year bonds issued by mortgage banks slid to minus 0.2 per cent, compared to a level of plus 5 per cent a decade ago.

That means investors are essentially paying for the privilege of lending money into Europe’s largest property sector. Economic logic — or gravity — has been turned on its head.

If that were not bizarre enough, consider this: in Denmark, some financial institutions are offering borrowers “negative” mortgages that pay interest; treasurers of major German companies are muttering about their bonds trading with negative yields; and yields on 10-year government bonds in France and Sweden have fallen into negative territory too, joining Germany and Japan.

Overall, the global pile of negative yielding debt has swelled above $12.5tn, breaking the record set in 2016. Even in America, the yield on 10-year Treasuries recently fell below 2 per cent. That might not look dramatic since it is still positive in nominal terms. But when adjusted for core inflation (about 2 per cent) it equates to a near-negative real rate. This is remarkable given that the US just notched up an economic growth rate of 3.1 per cent in the first quarter.”
Title: Re: Negative interest rates take investors into surreal territory
Post by: no_free_lunch on June 28, 2019, 05:30:57 PM
Well I will be getting a mortgage if this happens.

I think boring slow to no growth companies with large dividends should do ok. Telecom companies come to mind.  REITs could do ok. The dividend looks better and they can refinance at better rates.  Really all equities are undervalued in this case but I really like dividends as I could see investors getting desperate and bidding them up.   

I think the hard question is what does this imply for economic growth.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Packer16 on June 28, 2019, 06:00:34 PM
That is only the case if you assume inflation.  In a deflationary world, an inverted yield curve is normal as your money is becoming worth more the longer you hold it.

Packer
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on June 28, 2019, 06:33:16 PM
In Europe, home prices have been on a tear for years. They are going up faster than Silicon Valley.

Though housing is 40% of the CPI, disgusting governments and central bankers have created  negative mortgage rates in Denmark, 0% 10-year in France, 0.5% 10-year in Portugal and Spain.

All these countries have zooming house prices. Faked inflation numbers have given central bankers an excuse to blow a housing bubble, just like they did in the US in 2008.

How do they report 0.5% inflation when the biggest CPI component is climbing 7% a year? "Imputed Rents"
Title: Re: Negative interest rates take investors into surreal territory
Post by: alpha on June 28, 2019, 11:00:53 PM
Anyone catch when Munger commented about interest rates at this years AGM? He basically said they were abnormally low and would soon normalize.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on June 29, 2019, 01:11:17 AM
I see Denmark mentioned in the quote by Viking in the starting post in this topic.

This post is about my personal perception of Danish interest rate conditions, based on my actual cursory knowledge about the Danish market for mortgage bonds etc.

Finans Danmark : Bond rates (https://finansdanmark.dk/toerre-tal/boligstatistik/obligationsrenter/).

Translation of legend :

Red: Short Euro rate
Brown : Short rate [DKK]
Grey [sort of] : Long rate [likely DKK]

So the long [likely 30 years] fixed interest rate is right now 1.647 %. On top of that you have to pay a spread of ~1 % to the mortgage institution, in Danish "reservefondsbidrag" [translates to "reserve fund contribution"], which is the mortgage institutions running earnings on the mortgage. The spread can be a bit lower, based on your rating.

Mortgages with variable interest are typically rolled over after 1, 3 or 5 years. In Danish called "flexloans" - F1, F3 or F5. Refinancing rates are set under bond auctions at certain dates. What happens if the Danish mortgage bond market is - perhaps more or less - frozen at the dates of the future auctions? What happened to GGP comes to mind here.

To buy a home with mortgage [generally max. 80 % in mortgage] you have to have 5 % of the price as available cash, which can't be borrowed money, and after all other personal debt deducted [I think student loans in this particular calculation is excluded though.]

Based on your personal budget and a standardized minimum available amount of money for consumption based on the household composition, you are eligible for the mortgage for the house, if you can afford a mortgage with repayments over 30 years [likely depending on your age also] with fixed rate. [In this budget you naturally have to include the load of repayment of student loans.]

This practice is set by the Danish FSA - so to say as a "soft", but still de facto standard, meaning your bank can provide the last 15 % of the price as second layer financing, if it's willing to make a loan provision for the deviation.

I'm not up to date on the actual standards for minimum available amount of money for consumption for now some years, but last time I asked about it, I was surprised how high they were.

You can opt for a "punch card" on your mortgage with ten punches [each punch is a year without repayment, subject to that the mortgage is held within agreed duration], if the economic situation for the total household changes to the worse, compared to the budget [unemployment etc.].

This practice makes a lot of sense to me.

So the "free" debt, that really isn't free [but still cheap], is certainly not available for everybody here in Denmark.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Spekulatius on June 29, 2019, 06:50:05 AM
^ the above provisions seem easier than the provisions for a conforming mortgage in the US. However on the other hand, who is going to say that with a 1.6% interest rate, a 2.5% cap rate isn’t reasonable? This would presumably make the interest cost of a home the same than owning, even if you include the cost of maintaining the house (~1% of purchase price).

There ar pretty cheap (relative to NAV) real estate stocks one can buy in the UK for example. U.K. will probably follow down the EU it’s interest rates over time.

Of course banks and life insurance companies are screwed.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on June 29, 2019, 08:07:53 AM
10% home price rise with an 80% mortgage, is a 50% return on investment within one year.

Draghi wants to ease even more.

Volcker has a simple suggestion: if you don't want deflation, don't blow bubbles.

^ the above provisions seem easier than the provisions for a conforming mortgage in the US. However on the other hand, who is going to say that with a 1.6% interest rate, a 2.5% cap rate isn’t reasonable? This would presumably make the interest cost of a home the same than owning, even if you include the cost of maintaining the house (~1% of purchase price).

There ar pretty cheap (relative to NAV) real estate stocks one can buy in the UK for example. U.K. will probably follow down the EU it’s interest rates over time.

Of course banks and life insurance companies are screwed.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on June 29, 2019, 09:11:22 AM
10% home price rise with an 80% mortgage, is a 50% return on investment within one year.

Draghi wants to ease even more.

Volcker has a simple suggestion: if you don't want deflation, don't blow bubbles.

RuleNumberOne,

Perhaps I misinterpret your post here, but please try to invert your post, by assuming a 10 percent price decrease instead. Draghi & Volcker do not set market prices on real estate - buyers and sellers do.

This post is not meant condescending towards you. I assume we all know about the mechanics of the use of leverage, actually.
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on June 29, 2019, 04:45:26 PM

Draghi & Volcker do not set market prices on real estate - buyers and sellers do.


Yes, but a central bank controls the growth path of the unit of account, which is the main measuring stick for those "buyers and sellers". 

The central bank can almost completely dictate the size of the nominal economy going forward.

The below table kinda shows that housing (as % of nominal GDP) has been relatively constant.

So at a high level, can't Draghi and Volcker largely determine the nominal price of housing over a decently long time frame?

https://www.nahb.org/-/media/Sites/NAHB/research/housing-economics/housings-economic-impact/housing-contribution-gdp-q1-2019-0426.ashx?la=en&hash=DB4820E7942613C16F65F3BF6739E0462AC168EE


(Would add that there's no iron law that housing must be a fixed % of GDP - Its just that with various zoning laws, it's (imo) likely to stay relatively constant.  Without those laws, there's a (good?) chance that housing would represent an ever decreasing % of GDP, much like food has done over the last century)

https://cdn.theatlantic.com/static/mt/assets/business/1900%201950%202003.png
Title: Re: Negative interest rates take investors into surreal territory
Post by: SharperDingaan on June 30, 2019, 07:14:22 AM
Over the long-term, CB's will do everything thet can to ensure that the nominal value of housing does NOT decline. If only because municipal taxes are an annual % of value, & DIY/Construction/Hard Goods etc. rely on the nominal value of property continually rising. At the macro level, for housing to fall in real terms; inflation would have to continuously exceed targeted growth in money supply (2% in most cases). Very unlikely, and for quite some time.

The reality of course is that the higher property values go, the less a conventional mortgage works.
In todays environment, cashflow for debt service is static (or declining, re the 'gig' economy); under conventioal mortgages, higher property values, can only be financed if rates are lower. Solutions to date, have been to change the physical asset (size, location, shared ownership, etc.); not the method of financing.

A conventional mortgage with a negative rate, means the banker pays you to borrow! Not going to happen.
The solution of course is to seperate the land and dwelling values; the bank buys the land and leases it to you for the useful life of the dwelling, you just buy the dweling to live in. At end of land lease the dwelling is demolished, and replaced with new build of highest & best use at the time. Essentially a version of the existing UK approach, but where pension funds ultimately own the land, you live in the most up-to-date dwelling practical, and we all benefit from systemic baked-in economic growth/recycling.

People just need an affordable place to live & raise families; they don't need to own the land that the dwelling stands on.

SD
 




Title: Re: Negative interest rates take investors into surreal territory
Post by: kab60 on June 30, 2019, 08:14:35 AM
No idea what to make of it, but my 30 year mortrage runs at minus 0,43 pct. at the moment (floating rate, changes a couple of times a year) with the first 10 years being non-amortizing, but since the rate is negative I actually do pay down the loan.

Means there's quiet a bit more to invest each month (coming from 3 pct. amortizing fixed 30 year), but strange times indeed.

Couple of weeks ago banks here in Denmark opened a new mortgage bond fixed 30 year at 1 pct. And Austria are looking to sell a 100 year bond that pays 1,2 pct. annually. Strange times indeed. I could see the attraction in loaning at 1 pct. for 30 years, but the risk/reward from the other side looks pretty poor I'd think. Since I'm not very interest rate sensitive I'll stick to ultrashort duration (which has been a winner for a looong time), but if rates actually DO go up a 1 pct. loan would be big.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on June 30, 2019, 09:44:40 AM
Aren't home prices in Denmark going up a lot though? Netherlands has issued a lot of interest-only mortgages over the last few years and home prices are going up 10% a year.

The central planners claim inflation is low in Germany. Yet, Berlin passed a five-year rent freeze a few weeks ago because rents were going up a lot (7-10% a year for the last few years.)

http://www.bbc.com/capital/story/20190226-berlins-radical-plan-to-stop-rocketing-rents

Insurers and other such bondholders are the ones who are getting robbed by the central planners. It is safe to say nobody from the Bundesbank will ever be the chief of the crooked ECB, poor Weidmann.

We had negative amortization and interest-only mortgages in 2007 in the US too. But we haven't had them for the last 10 years, US regulators have been very strict.
Title: Re: Negative interest rates take investors into surreal territory
Post by: kab60 on June 30, 2019, 10:57:22 AM
Home prices in Denmark is very divided. I live in a flat in Copenhagen which has basically doubled since 2011, and it's more expensive in Copenhagen than it was in 2007, but prices have actually come down in the last year - anectodally around 10 pct. But that's due to Danish politics (stricter lending requirement, down payment of 5 pct., expected increase in property taxes on apartments). Other parts of the city are still way below 2007 levels.

Rates being where they are the housing market here doesn't look expensive. I ran the math the other day since a combination of falling RE prices plus falling rates got me interested, and if I put down 20 pct. LTV cash and borrow 80 pct. at 1 pct. 30 year loan (amortizing) I could probably get a 8-10 pct. (levered) return from paying down the loan since the cost of renting is "way" higher than the cost of buying.

Now I don't wanna go long RE atm (and I am somewhat already with our own flat) - espescially with all hassle involved - but the math is interesting since the Danish RE system is a bit unique. So you can be wayyy technically insolvent and the debt still isn't possible to call for the lenders (it's a bond) as long as you pay on time. So the risk is you can't find someone who'll rent your place or rents drop massively, but all trends point to increased urbanization.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on June 30, 2019, 12:15:17 PM
Great that you shed some light and nuances on the Danish situation about real estate prices, kab, thank you,

I have a couple of more technical questions about how your mortgage with negative interest works :

1. In your post about your mortgage you indicated, that the negative interest isn't paid out to you, but is booked as a repayment on the principal [,so despite you have a standing loan/mortgage for the first ten years, the balance of the mortgage is going down over time with the negative interest payments]. Have I understood this correctly? [Cigarbutt actually also posted about this phenomen recently here on CoBF not so long ago.]

2. I suppose you are still charged reserve fund contributions, and are paying them. Have I understood this correctly?

- - - o 0 o - - -

Yes, indeed, the whole thing is very weird.
Title: Re: Negative interest rates take investors into surreal territory
Post by: kab60 on June 30, 2019, 12:51:16 PM
Great that you shed some light and nuances on the Danish situation about real estate prices, kab, thank you,

I have a couple of more technical questions about how your mortgage with negative interest works :

1. In your post about your mortgage you indicated, that the negative interest isn't paid out to you, but is booked as a repayment on the principal [,so despite you have a standing loan/mortgage for the first ten years, the balance of the mortgage is going down over time with the negative interest payments]. Have I understood this correctly? [Cigarbutt actually also posted about this phenomen recently here on CoBF not so long ago.]

2. I suppose you are still charged reserve fund contributions, and are paying them. Have I understood this correctly?

- - - o 0 o - - -

Yes, indeed, the whole thing is very weird.
1) Yes, the negative rent reduces our outstanding loan balance - even with the first ten years being "interest only". I think they struggle somewhat with the implications of paying to lend me money so they reduce debt outstanding instead.

2) Yes, in practice I do pay a bit after all costs and taxes. So the interest is what it is (-0,43 pct. now), but then the mortgage servicer charges some 80 basis points for servicing the loans which is variable depending on loan type (lower on fixed rate loan than floating), LTV etc. My mortgage servicer is Nykredit which is membership owned, so if you have your mortgage loan through them (which is actually a bond, then you get a discount on the servicing (like 15 basis points of discount I think). And then they pay you 250 DKK each quarter as well. :) It's pennies but so is the payments on the mortgage. No wonder banks are struggling.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on June 30, 2019, 01:22:53 PM
Thank you for the elaboration here, kab - it's much appreciated, & nice to actually know.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on June 30, 2019, 01:51:16 PM
More Internet searching found:

ECB covers up banking problems at Monte Paschi:
https://www.bloomberg.com/graphics/2019-opinion-monte-paschi/?srnd=premium
"The manner in which the ECB tackled the Italian lender’s problems, its first big test as a banking regulator, threatens to undermine its credibility. ECB President Mario Draghi has yet to win over the many analysts, politicians and others who remain skeptical of the authority’s ability to act as a strong, strict and independent supervisor. To restore investor faith in Europe’s banks, the regulator needs to be more accountable and transparent. This bailout suggests that the ECB may not be up to the task."

IMF warned that Portugal has a real estate bubble again.
https://www.theportugalnews.com/news/imf-warns-of-risk-of-real-estate-bubbles-in-portugal/46330

Dutch central bank warns housing market is a risk
https://nltimes.nl/2019/06/05/dutch-housing-market-biggest-stability-risk-netherlands-central-bank-warns-hard-brexit

Spain property prices tripled between 1996-2003. Needs more reflation before recapturing the peak
https://seekingalpha.com/article/4266705-busted-housing-bubble-1-morphs-housing-bubble-2-spain


ECB says it will keep rates low for another year. I think the re-bubbling will continue for a while even as they pretend there is no inflation. The ECB is a banana central bank.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on June 30, 2019, 02:23:19 PM
https://www.bloomberg.com/graphics/2019-opinion-monte-paschi/?srnd=premium

To get an idea of what the ECB is capable of and why they need zero rates for at least another year (or maybe for the next 100 years), these are some quotes from the article. Draghi was chief of Italy's central bank before he became ECB chief.

"The bank took to masking its burgeoning losses with a series of complex derivatives deals. Those transactions were hidden from public view until I later reported on them. Once they were disclosed, Monte Paschi had to restate its accounts twice."

To pass muster with regulators, firms need a ratio of at least 4.5%—or more than seven times what the report estimated Monte Paschi had at the time.

In short, the ECB knew in 2016 that the Italian lender appeared to be insolvent. Neither party disclosed this critical assessment, even as the bank’s bonds and shares were trading publicly


It looks like Monte Paschi had a severe capital shortfall around the time of its bailout. EU rules should have disqualified it from getting the so-called precautionary recapitalization it received.

But 17% of its loans are still classified as nonperforming, a figure that is almost twice as large as the average for Italy’s top nine banks, according to Bloomberg data.

"State and nonprofit ownership had made the bank vulnerable to local political interference. It frequently lent money to court power. In doing so, it tended to overlook credit risk."

Monte Paschi’s failings included:
Accounting for collateral twice, or even multiple times, with different values;

Title: Re: Negative interest rates take investors into surreal territory
Post by: SharperDingaan on June 30, 2019, 03:35:56 PM
Lots of possibilities here ...

Monte Paschi evidences that the impact of a European CB put on a DSIB (Domestic Systemically Important Bank); is much, much higher than most would expect. The DB, or a Monte Paschi, that suffers a market crises of confidence is not going to be allowed to fail - no matter what. So when the sh1te seriously hits the fan, use the opportunity to buy a longer dated call at a low strike, on said bank ;)

In most places only a domestic citizen, can buy domestic RE using a domestic mortgage; however it is not particularly onerous to get around the restriction if you hold 'dual' (EU/UK) citizenship. Put up the equity on that Danish property, let the property appreciate 20%, remortgage to pay yourself back, and let the bank pay down your mortgage at 0.49%/yr ;)

... and if it were a Danish bank that got into trouble, much of that equity you put up would be profit!

SD
Title: Re: Negative interest rates take investors into surreal territory
Post by: Spekulatius on June 30, 2019, 06:32:48 PM
Lots of possibilities here ...

Monte Paschi evidences that the impact of a European CB put on a DSIB (Domestic Systemically Important Bank); is much, much higher than most would expect. The DB, or a Monte Paschi, that suffers a market crises of confidence is not going to be allowed to fail - no matter what. So when the sh1te seriously hits the fan, use the opportunity to buy a longer dated call at a low strike, on said bank ;)

In most places only a domestic citizen, can buy domestic RE using a domestic mortgage; however it is not particularly onerous to get around the restriction if you hold 'dual' (EU/UK) citizenship. Put up the equity on that Danish property, let the property appreciate 20%, remortgage to pay yourself back, and let the bank pay down your mortgage at 0.49%/yr ;)

... and if it were a Danish bank that got into trouble, much of that equity you put up would be profit!

SD

I beg to differ on the long dated call. the ECB will not let a larger bank fail, but they will have no problem to make the equity a zero and run it as a state old bank or put it into the fold of an existing bank. In Europe, having the government own and run a bank doesn’t have the same stigma. If the German government would have to take over DB, nobody in Germany would give much of a hoot about it.

If we do get European style interest rates here, the US banks all will suffer greatly from reduced profitability, as will pension funds and insurance companies.
Title: Re: Negative interest rates take investors into surreal territory
Post by: SharperDingaan on July 01, 2019, 05:58:50 AM
Lots of possibilities here ...

Monte Paschi evidences that the impact of a European CB put on a DSIB (Domestic Systemically Important Bank); is much, much higher than most would expect. The DB, or a Monte Paschi, that suffers a market crises of confidence is not going to be allowed to fail - no matter what. So when the sh1te seriously hits the fan, use the opportunity to buy a longer dated call at a low strike, on said bank ;)

In most places only a domestic citizen, can buy domestic RE using a domestic mortgage; however it is not particularly onerous to get around the restriction if you hold 'dual' (EU/UK) citizenship. Put up the equity on that Danish property, let the property appreciate 20%, remortgage to pay yourself back, and let the bank pay down your mortgage at 0.49%/yr ;)

... and if it were a Danish bank that got into trouble, much of that equity you put up would be profit!

SD

I beg to differ on the long dated call. the ECB will not let a larger bank fail, but they will have no problem to make the equity a zero and run it as a state old bank or put it into the fold of an existing bank. In Europe, having the government own and run a bank doesn’t have the same stigma. If the German government would have to take over DB, nobody in Germany would give much of a hoot about it.

If we do get European style interest rates here, the US banks all will suffer greatly from reduced profitability, as will pension funds and insurance companies.

It's really just a variant of a vega trade, there's no intent to own for any significant length of time. Simply buy when uncertainty/volatility is high, & the financial press is daily making the case that XYZ bank is about to collapse. Sell when the CB announces it support, and uncertainty/volatility declines. The more financial press/political machinery involved, the better it works. Granted there's always the possibility of outright nationalization, but it's usually telegraphed, and still a 'dead cat' bounce.

High maintenance, but relatively low risk

SD

 
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 01, 2019, 09:32:21 AM
... ... So at a high level, can't Draghi and Volcker largely determine the nominal price of housing over a decently long time frame? ...

Hi Jim,

It's a personal pleasure for me  to "meet" you for the first time here on CoBF.

Here I'm just grabbing a post by RuleNumberOne in the WFC topic in in Investment Ideas forum :

Denmark has negative mortgage rates and booming house prices. Governments and central bankers in Europe are far more crooked than the US. Throughout Europe you have rock-bottom interest rates and booming house prices. Debauchery of the currency is a mild description. How long can this go on?

https://www.globalpropertyguide.com/Europe/Denmark/Price-History (https://www.globalpropertyguide.com/Europe/Denmark/Price-History)

"Denmark´s negative interest rates continue to work their dangerous magic on both the housing and mortgage markets.

The price index of owner-occupied flats in Denmark rose by 7.88% (7.25% when adjusted for inflation) during the year to February 2018, an acceleration from last year´s growth of 6.87% (5.81% when adjusted for inflation), according to Statistics Denmark."

[Embedded quotations in RuleNumberOne's post omitted here for less dense posting.]

Please note the following in the article linked to by RuleNumberOne:

Quote
... Effective January 1, 2018, the government introduced tighter lending regulations, in an effort to reduce the share of more risky interest rate and repayment-free mortgages on the overall mortgage lending portfolio of banks. Banks will be limited from offering housing loans that do not have fixed interest rates, or monthly installments. Moreover, the number of mortgages available to households seeking to borrow more than four times their income, or more than 60% of the value of the property will be heavily restricted.

"These are reasonable guidelines that should ensure that homeowners are more robust," said Lars Krull of Aalborg University.

The move is also supported by Nordea economist Jan Storup Nielsen, who believes that the move "represents a major departure from previous policies and will likely help reduce the risk of a new housing bubble."

In the past recent years, the International Monetary Fund (IMF) had been urging the Danish government to reverse its negative interest rates mandate and introduce new policies to avoid a disastrous housing bubble. ...

Add to that the 5 percent down payment of non-borrowed money imposed requirement mentioned by kab60 earlier in this topic. Please also note that most of the numbers mentioned in the article are YE2017 numbers. A lot of water has run through the river since then, and the imposed regulation has had effect, to avoid speculation, home-flipping and other similar kinds of folly going on, because a lot of interested buyers has been pulled out of the market, because they have lost the ability to bid in as prices have gone up, creating what I percieve as a high equilibrium - which was the purpose of the new regulation.

So for tiny Denmark, - in short - the answer to your question is actually : No. Draghi [et al.] does not decide or have jurisdiction/power over supplementary national regulation.

When looking on what's going on in EU with interest rates etc., you can't just look at it as whole. The economic situations & financial systems are only to various degrees similar among european countries.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 01, 2019, 02:53:03 PM
... . Do we care if negative rates are here to stay? How does this change the investment process? ...

I'm sorry for double posting here in this topic. Now back to Viking's starting post here, ref. the quote above.

I think it's important here to distinguish with regard to geographical areas. [For my part : Between US banks and European banks - I own both.]

US Banks :

There seem to be a general sentiment as of now, that US interest rates will be lowered [also here on CoBF - at least partially] - perhaps even so the steering interest rates may end up near zero, or even negative. With regard to that, I'm in the same camp as Jurgis [posted by Jurgis somewhere else here on CoBF recently] : Why should the FED lower interest rates, when USA is running at low, but still a fairly steady & positive clip, combined with a public deficit? [I don't get it, but then again : What do I know.]

European Banks:

I can here only speak as Danish citizen, what I can say is that the pressure on Net Interest Margin in Danish banks is very real, and as a Danish bank customer, I can feel & see it as being very real.

The consequences are already here and visible : The reach for non-interest earnings in Danish banks has become more aggressive, and to me it has already crossed the line of sound, healthy, prudent & most of all : honest banking. [To me "honest banking" is in the interest the customer, not the bank.]

I'll document it here, with anecdotal stuff, based on personal experiences and documentation. Stuff about Danske Bank however will go to the topic I started about Danske Bank A/S in the Investment Ideas forum today.

- - - o 0 o - - -

This naturally matters for investing in both US Banks & European Banks. I may be wrong about the future development of US interest rates, and what's going here may be relevant for a judgement about what will happen with the behavior of the US Banks.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Viking on July 01, 2019, 04:54:11 PM
... . Do we care if negative rates are here to stay? How does this change the investment process? ...

I'm sorry for double posting here in this topic. Now back to Viking's starting post here, ref. the quote above.

I think it's important here to distinguish with regard to geographical areas. [For my part : Between US banks and European banks - I own both.]

US Banks :

There seem to be a general sentiment as of now, that US interest rates will be lowered [also here on CoBF - at least partially] - perhaps even so the steering interest rates may end up near zero, or even negative. With regard to that, I'm in the same camp as Jurgis [posted by Jurgis somewhere else here on CoBF recently] : Why should the FED lower interest rates, when USA is running at low, but still a fairly steady & positive clip, combined with a public deficit? [I don't get it, but then again : What do I know.]

European Banks:

I can here only speak as Danish citizen, what I can say is that the pressure on Net Interest Margin in Danish banks is very real, and as a Danish bank customer, I can feel & see it as being very real.

The consequences are already here and visible : The reach for non-interest earnings in Danish banks has become more aggressive, and to me it has already crossed the line of sound, healthy, prudent & most of all : honest banking. [To me "honest banking" is in the interest the customer, not the bank.]

I'll document it here, with anecdotal stuff, based on personal experiences and documentation. Stuff about Danske Bank however will go to the topic I started about Danske Bank A/S in the Investment Ideas forum today.

- - - o 0 o - - -

This naturally matters for investing in both US Banks & European Banks. I may be wrong about the future development of US interest rates, and what's going here may be relevant for a judgement about what will happen with the behavior of the US Banks.

“There seem to be a general sentiment as of now, that US interest rates will be lowered [also here on CoBF - at least partially] - perhaps even so the steering interest rates may end up near zero, or even negative. With regard to that, I'm in the same camp as Jurgis [posted by Jurgis somewhere else here on CoBF recently] : Why should the FED lower interest rates, when USA is running at low, but still a fairly steady & positive clip, combined with a public deficit? [I don't get it, but then again : What do I know.]”

John, i really enjoyed reading your post, especially the part i quoted above. It looks to me like the globe might be slowly slipping into a deflationary spiral. What will stop the slow spiral we are seeing? China seems more constrained in options than in 2010. Japan to the rescue? No. How about Europe? They look to be following down Japan’s path. US? Trump has already slashed taxes and is running very large deficits so spending more (and running even bigger deficits) is likely not an option. The Fed can cut rates. Which is wherevwe are at.

I am watching to see if the global slowdown continues or if it improves in Q3/Q4. If we actually get a recession in the US in 2020 we will be in unchartered waters in terms of what central banks will do and the impact those actions will have on the larger economy over time.

I think we also could see a shift from Trump from a focus on tarriff war to currency war. It this happens we will get a brand new layer of instability. Interesting times :-)
Title: Re: Negative interest rates take investors into surreal territory
Post by: TwoCitiesCapital on July 01, 2019, 06:04:41 PM

Draghi & Volcker do not set market prices on real estate - buyers and sellers do.


Yes, but a central bank controls the growth path of the unit of account, which is the main measuring stick for those "buyers and sellers". 

The central bank can almost completely dictate the size of the nominal economy going forward.

The below table kinda shows that housing (as % of nominal GDP) has been relatively constant.

So at a high level, can't Draghi and Volcker largely determine the nominal price of housing over a decently long time frame?

https://www.nahb.org/-/media/Sites/NAHB/research/housing-economics/housings-economic-impact/housing-contribution-gdp-q1-2019-0426.ashx?la=en&hash=DB4820E7942613C16F65F3BF6739E0462AC168EE


(Would add that there's no iron law that housing must be a fixed % of GDP - Its just that with various zoning laws, it's (imo) likely to stay relatively constant.  Without those laws, there's a (good?) chance that housing would represent an ever decreasing % of GDP, much like food has done over the last century)

https://cdn.theatlantic.com/static/mt/assets/business/1900%201950%202003.png

Agreed. The more financial-ized housing becomes (i.e. the more house finance and package into a product to sell to retail investors), the more it's value depends on interest rates and money creation and the less on its fundamental value.

Back in the days of banks keeping mortgages on their books and buyers having to put 30% down, you wouldn't have near the housing prices we see today.

The prices are this high because with rates this low, you can finance 97% of the house and still end up with a reasonable mortgage payment - and banks don't care because they just package and sell it to retail investors who are just glad they can beat 2% on the 10-year treasury.

Upside is more mortgages and more affordable mortgages. Downside is housing inflation and increasing housing's dependence on low interest rates.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 01, 2019, 09:33:27 PM
https://www.ft.com/content/c060e162-98c1-11e9-8cfb-30c211dcd229

"In Frankfurt, Germany’s financial centre, prices have doubled since 2010...

...real house prices in Amsterdam rose 64 per cent in the five years to September 2018, but real disposable household income grew just 4.4 per cent in that time, despite ultra-low unemployment."

Klaas Knot, head of the Dutch central bank who also sits on the ECB governing council, said low interest rates “are a contributing factor”, with mortgage rates “down to levels where I don’t think we’ve seen them before in the Netherlands”.

Bloomberg claims the same Klaas Knot thinks inflation is too low
https://www.bloomberg.com/opinion/articles/2019-07-01/stock-market-can-t-be-fully-brain-dead-right

"Dutch Governor Klaas Knot, typically considered on the hawkish wing of the Governing Council, said it was “indisputable” that inflation is too low. "
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 02, 2019, 02:26:04 PM

Denmark has negative mortgage rates and booming house prices. Governments and central bankers in Europe are far more crooked than the US. Throughout Europe you have rock-bottom interest rates and booming house prices. Debauchery of the currency is a mild description. How long can this go on?

https://www.globalpropertyguide.com/Europe/Denmark/Price-History (https://www.globalpropertyguide.com/Europe/Denmark/Price-History)

"Denmark´s negative interest rates continue to work their dangerous magic on both the housing and mortgage markets.

The price index of owner-occupied flats in Denmark rose by 7.88% (7.25% when adjusted for inflation) during the year to February 2018, an acceleration from last year´s growth of 6.87% (5.81% when adjusted for inflation), according to Statistics Denmark."

So for tiny Denmark, - in short - the answer to your question is actually : No. Draghi [et al.] does not decide or have jurisdiction/power over supplementary national regulation.

When looking on what's going on in EU with interest rates etc., you can't just look at it as whole. The economic situations & financial systems are only to various degrees similar among european countries.

Hi John,

Good meeting you as well and great discussion. There's a lot of moving parts imo regarding monetary policy as it relates to asset prices, so i'll try to list out at least my thoughts in bullet point order:

#1 I'd argue that monetary policy in the EU has been TOO TIGHT, not too loose.  Yes, the supply of money has gone up quite a bit in the EU, but the demand for money has gone up even further.  I think it's helpful to judge tightness or looseness of monetary policy based on nominal G.D.P. (which has been very low in the EU since 2008).  Current short term interest rates are not a good metric for judging monetary policy and instead, low short term interest rates are usually a sign that monetary policy has (counterintuitively) been too tight.  Theres a lot to this, and I explain it in much more detail across 50-100 pages in my 2017 and 2018 letters (link below in my signature)

#2 Because monetary policy has been too tight, this has led to lower Long term bond yields in the EU.  As Buffett says, LT bond yields act like gravity on asset prices.  Again, it's counterintuitive, but the implication is that because tight monetary policy led to lower bond yields, this results in higher house prices as mortgage rates tend to track the low bond yields in the EU.

I'm no expert on the specifics of the denmark housing market, and surely i'm missing some factors here (local building codes, zoning, etc), but at a high level i'm not surprised to see house prices rising. But its not because the ECB has been printing too much money...its the opposite...they haven't printed enough money.

I'd like to see the ECB drop its current targets and instead promise to do unlimited open market operations until NGDP is growing at 5% a year.  Assuming they do this i'd argue that

1) wages would go up across the EU
2) real asset prices would drop (real house prices drop and  (which also reduces income inequality)
3) populism and political tensions are reduced.

edit: as a final example showing how ECB largely controls asset prices at a high level.  Lets imagine 2 scenarios. The first scenario (akin to what we currently have) is that ECB keeps money growth low and inflation low over the next 100 years.  In this case, I'd expect nominal house prices to grow at a slow rate in line with money growth, but for there to be a one time boost in real house prices as the housing market adjusts to lower interest rates.   At the other extreme lets imagine the ECB prints a lot more money than they currently are to the point where inflation averges 10%/yr over the next 100 years.  in this case, nominal house prices would rise much more quickly than in scenario 1 (again, nominal house prices tend to track with inflation), however i'd expect real house prices to be a bit lower than in scenario 1, as the high interest rates act as a drag to real asset prices (scenario 2 would also likely result in stocks having lower P/E ratios (proxy for "real asset prices") but HIGHER nominal earnings growth/stock prices over those 100 years).  I'm probably not explaining this very well so welcome any feedback!
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 02, 2019, 10:10:05 PM
The problem in Europe is the absence of a free market.

- Bad borrowers never punished
- Bad lenders never punished
- Bad regulators never punished
- Bad politicians never punished.

Monte Paschi bailed out:
 - 17% non-performing loans
 - accounting for same collateral with different values multiple times
 - complex derivatives to hide losses.


What do we have now:
- Retroactive Rent freezes in Berlin (Wealth confiscation) to stop raging housing inflation in Germany
- Banks continue to make interest only loans, don't compensate for credit risk.
- ECB covers up insolvency, investors don't trust bank numbers.


It is like trying to generate inflation in Alabama with negative rates, regardless of how much capital gets misallocated. It would eventually work, but only after we have created a bubble that is as big as 1929 + 1999 + 2008. There is no escape from that box.
Title: Re: Negative interest rates take investors into surreal territory
Post by: CorpRaider on July 03, 2019, 04:56:50 AM
Rule, you are a good noob.  I enjoy and value your contributions to this site.
Title: Re: Negative interest rates take investors into surreal territory
Post by: TwoCitiesCapital on July 03, 2019, 06:11:34 AM

Denmark has negative mortgage rates and booming house prices. Governments and central bankers in Europe are far more crooked than the US. Throughout Europe you have rock-bottom interest rates and booming house prices. Debauchery of the currency is a mild description. How long can this go on?

https://www.globalpropertyguide.com/Europe/Denmark/Price-History (https://www.globalpropertyguide.com/Europe/Denmark/Price-History)

"Denmark´s negative interest rates continue to work their dangerous magic on both the housing and mortgage markets.

The price index of owner-occupied flats in Denmark rose by 7.88% (7.25% when adjusted for inflation) during the year to February 2018, an acceleration from last year´s growth of 6.87% (5.81% when adjusted for inflation), according to Statistics Denmark."

So for tiny Denmark, - in short - the answer to your question is actually : No. Draghi [et al.] does not decide or have jurisdiction/power over supplementary national regulation.

When looking on what's going on in EU with interest rates etc., you can't just look at it as whole. The economic situations & financial systems are only to various degrees similar among european countries.

Hi John,

Good meeting you as well and great discussion. There's a lot of moving parts imo regarding monetary policy as it relates to asset prices, so i'll try to list out at least my thoughts in bullet point order:

#1 I'd argue that monetary policy in the EU has been TOO TIGHT, not too loose.  Yes, the supply of money has gone up quite a bit in the EU, but the demand for money has gone up even further.  I think it's helpful to judge tightness or looseness of monetary policy based on nominal G.D.P. (which has been very low in the EU since 2008).  Current short term interest rates are not a good metric for judging monetary policy and instead, low short term interest rates are usually a sign that monetary policy has (counterintuitively) been too tight.  Theres a lot to this, and I explain it in much more detail across 50-100 pages in my 2017 and 2018 letters (link below in my signature)

#2 Because monetary policy has been too tight, this has led to lower Long term bond yields in the EU.  As Buffett says, LT bond yields act like gravity on asset prices.  Again, it's counterintuitive, but the implication is that because tight monetary policy led to lower bond yields, this results in higher house prices as mortgage rates tend to track the low bond yields in the EU.

I'm no expert on the specifics of the denmark housing market, and surely i'm missing some factors here (local building codes, zoning, etc), but at a high level i'm not surprised to see house prices rising. But its not because the ECB has been printing too much money...its the opposite...they haven't printed enough money.

I'd like to see the ECB drop its current targets and instead promise to do unlimited open market operations until NGDP is growing at 5% a year.  Assuming they do this i'd argue that

1) wages would go up across the EU
2) real asset prices would drop (real house prices drop and  (which also reduces income inequality)
3) populism and political tensions are reduced.

edit: as a final example showing how ECB largely controls asset prices at a high level.  Lets imagine 2 scenarios. The first scenario (akin to what we currently have) is that ECB keeps money growth low and inflation low over the next 100 years.  In this case, I'd expect nominal house prices to grow at a slow rate in line with money growth, but for there to be a one time boost in real house prices as the housing market adjusts to lower interest rates.   At the other extreme lets imagine the ECB prints a lot more money than they currently are to the point where inflation averges 10%/yr over the next 100 years.  in this case, nominal house prices would rise much more quickly than in scenario 1 (again, nominal house prices tend to track with inflation), however i'd expect real house prices to be a bit lower than in scenario 1, as the high interest rates act as a drag to real asset prices (scenario 2 would also likely result in stocks having lower P/E ratios (proxy for "real asset prices") but HIGHER nominal earnings growth/stock prices over those 100 years).  I'm probably not explaining this very well so welcome any feedback!

Why is it the low rates have allowed for massive real estate inflation, but not equity markets?

Europe is dirt cheap on a relative basis to the U.S. If low rates act as a guaranteed inflator of asset prices, I would think European equities would've trounced U.S. equities over the past 5-years - but instead they've underperformed massively while the U.S. was raising rates?
Title: Re: Negative interest rates take investors into surreal territory
Post by: no_free_lunch on July 03, 2019, 06:58:59 AM
TwoCities, my opinion is that interest rates are more tightly coupled to real estate than equities.  It's standard practice to borrow to buy a house, quite rare in fact not to use debt.  With equities it's much less common to use debt and really it's a dangerous thing to do.   Maybe it's just that simple?  I agree that if markets are efficient there shouldn't be such a divergence but perhaps markets aren't that efficient.
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 03, 2019, 07:03:44 AM

Why is it the low rates have allowed for massive real estate inflation, but not equity markets?

Europe is dirt cheap on a relative basis to the U.S. If low rates act as a guaranteed inflator of asset prices, I would think European equities would've trounced U.S. equities over the past 5-years - but instead they've underperformed massively while the U.S. was raising rates?

Yeah its definitely not a guarantee and theory would certainly be more accurate in a completely closed economy. My guess is many are avoiding EU equities because earning growth is lower there than in the US.  That said, i think CAPE for EU equities has been around 20 back in 2018 so not super low either.

That said i don't think market has adjusted to lower rates in either US or Europe and would expect higher multiples going forward (of course this assume Fed and ECB keep their low inflation targets).

Just a guess, but with mortgages it seems more clear cut and would expect the housing market to adjust more quickly as there's less need to forecast future interest rates (assuming fixed mortgage).  If there are low rates when I buy a house thats all i kinda need to know.  I can calculate my monthly payments and determine affordability.  With stocks you necessarily have to guess at what rates will be in 5 years, 10 years, etc

edit: Would add that i'm talking about multiples here not total returns. In fact, while i think PE ratios will be higher going forward, I think total equity returns will be LOWER as earnings growth will be lower and tend to track the lower inflation/lower ngdp numbers going forward.  Somewhat over simplistic, but if we expect ECB to have slower growth than the US going forward then wouldn't surprise me to see US outperform on a total return basis, but for the EU to have higher PE ratios during that same time period.  Just a guess, and as others like TwoCities etc have pointed out, it may not always work exactly like this over even a 10 year time frame...other options for investing in equities outside one's own country, etc also complicates it a bit as  we've seen
Title: Re: Negative interest rates take investors into surreal territory
Post by: TwoCitiesCapital on July 03, 2019, 08:40:08 AM
TwoCities, my opinion is that interest rates are more tightly coupled to real estate than equities.  It's standard practice to borrow to buy a house, quite rare in fact not to use debt.  With equities it's much less common to use debt and really it's a dangerous thing to do.   Maybe it's just that simple?  I agree that if markets are efficient there shouldn't be such a divergence but perhaps markets aren't that efficient.

I'm not so certain.

Sure most people don't use debt to buy equities, but the equities themselves have every opportunity to to lever up, refinance at lower rates, acquire competitors, fund capital projects, etc to grow revenues and earnings.

I agree the effects might become more apparent more quickly in mortgages, but to have the evidence in one area of the market and not another that should be similarly impacted calls into question the assumptions that it's interest rates driving that. Particularly where the only place globally upholding the "low interest rates = high equity multiples" mantra seems to be the U.S.
Title: Re: Negative interest rates take investors into surreal territory
Post by: CorpRaider on July 03, 2019, 08:55:14 AM
Bear shitting here, but maybe the transmission mechanism to EAFE stonks is messed up because of sickly banks and regulations and whatever has prevented their corporate sector from dis-intermediating their banks as much as has been done in U.S.  Or maybe its because their governments/unions are ckblocking it like with the Renault deal.

Japan just needs Gordon Gecko/1980's guy to bash some corporate heads, imop.

RAFI has EAFE CAPE @ 16.4 (29th percentile of observed historical values) and EM @ 12.8X (17th percentile); US is at 54.6....so there's a little distance there, even assuming the foregone conclusion that Beyond Meat makes Nestle a zero.  haha
Title: Re: Negative interest rates take investors into surreal territory
Post by: Jurgis on July 03, 2019, 08:56:00 AM
CAPEs worldwide: https://www.starcapital.de/en/research/stock-market-valuation/
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 03, 2019, 09:26:55 AM
I think the reason is the Central Providers at the European Collectivism Bank (ECB) will buy homes at 120% of market value in a recession.

Banks lend to homeowners at negative interest rates without bothering about credit risk. In normal banking, they would have to charge a sufficiently high interest rate to compensate for default rates.

But the European Collectivism Bank provides everything - lavish pensions to whoever needs it by buying Greece 10-year at 2.1%, Italian 2-year at 0%.

At the current time, the Central Providers have bought corporate bonds, but it would be a stretch for the Central Providers to enrich stock market "speculators".

If you interview for a job at a European bank, make sure you say you don't know the meaning of the term "credit risk"

TwoCities, my opinion is that interest rates are more tightly coupled to real estate than equities.  It's standard practice to borrow to buy a house, quite rare in fact not to use debt.  With equities it's much less common to use debt and really it's a dangerous thing to do.   Maybe it's just that simple?  I agree that if markets are efficient there shouldn't be such a divergence but perhaps markets aren't that efficient.

I'm not so certain.

Sure most people don't use debt to buy equities, but the equities themselves have every opportunity to to lever up, refinance at lower rates, acquire competitors, fund capital projects, etc to grow revenues and earnings.

I agree the effects might become more apparent more quickly in mortgages, but to have the evidence in one area of the market and not another that should be similarly impacted calls into question the assumptions that it's interest rates driving that. Particularly where the only place globally upholding the "low interest rates = high equity multiples" mantra seems to be the U.S.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 03, 2019, 09:46:09 AM
RuleNumberOne,

Please stop spamming this topic with what I consider rubbish [at least in your last post here in this topic - naturally links to articles about what's discussed are OK]. This topic is actually started by what I consider one of the most successful & competent investors here on CoBF with regard to banks, who wants to discuss.

Pushback is always good. But please keep it fact based.

That said, your pushback has actually been massage to my own home bias, as a Danish citizen. I appreciate your energy to post links to relevant stuff. Time for me to lookup some IMF country reports and start reading again. Thank you.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 03, 2019, 11:16:36 AM
European Banking Authority : EBA Basel assessment sees impact driven by large banks [July 2nd 2019] (https://eba.europa.eu/-/eba-basel-assessment-sees-impact-driven-by-large-banks).

Quote
The European Banking Authority (EBA) presented today, during a public hearing, the results of its Basel III implementation assessment, which
includes a quantitative impact study (QIS) based on data from 189 EU banks, and a comprehensive set of policy recommendations in the area of credit and operational risk, output floor and securities financing transactions. This work, which responds to a Commission's call for advice, shows that the full implementation of Basel III in the EU, under the most conservative assumptions, increases the weighted average minimum capital requirement (MRC) by 24.4%, leading to an aggregate capital shortfall of EUR 135.1 bn. Importantly, the capital impact is almost entirely driven by large globally active banks. The impact on medium-sized banks is limited to 11.3% in terms of MRC, leading to a shortfall of EUR 0.9 bn, and on small banks to 5.5% MRC with a EUR 0.1 bn shortfall. The EBA will publish the full report by the end of July. ...
Title: Re: Negative interest rates take investors into surreal territory
Post by: Spekulatius on July 03, 2019, 02:35:15 PM
It s easy to bash the European bankers and the ECB, but what will happen to US banks and US insurance companies  when interest rates go the way they did Europe? US bank8ng has structurally less competition so it might be a bit better, but overall, I would expect NIM to compress to near European levels, which probably means ROE<10% and compressing P/tangible book <1.

The US still has a profitable credit card busInes and other niches that don’t exist in Europe, but banks have non-bank competitors in those.
 Insurers like BHF or LNC with long tail business or even FFH and BRK will be affected as well. Then we have issues with pension fund’s (Hello IBM, GE and many others).

The winners are probably utilities (unless their guaranteed returns gets revised down, as happened in Switzerland ), real estate, infrastructure  and probably solid growth business with or without capital needs that will command higher multiples.
Title: Re: Negative interest rates take investors into surreal territory
Post by: scorpioncapital on July 03, 2019, 02:36:03 PM
I think the reason is the Central Providers at the European Collectivism Bank (ECB) will buy homes at 120% of market value in a recession.

Banks lend to homeowners at negative interest rates without bothering about credit risk. In normal banking, they would have to charge a sufficiently high interest rate to compensate for default rates.

But the European Collectivism Bank provides everything - lavish pensions to whoever needs it by buying Greece 10-year at 2.1%, Italian 2-year at 0%.

At the current time, the Central Providers have bought corporate bonds, but it would be a stretch for the Central Providers to enrich stock market "speculators".

If you interview for a job at a European bank, make sure you say you don't know the meaning of the term "credit risk"

TwoCities, my opinion is that interest rates are more tightly coupled to real estate than equities.  It's standard practice to borrow to buy a house, quite rare in fact not to use debt.  With equities it's much less common to use debt and really it's a dangerous thing to do.   Maybe it's just that simple?  I agree that if markets are efficient there shouldn't be such a divergence but perhaps markets aren't that efficient.

I'm not so certain.

Sure most people don't use debt to buy equities, but the equities themselves have every opportunity to to lever up, refinance at lower rates, acquire competitors, fund capital projects, etc to grow revenues and earnings.

I agree the effects might become more apparent more quickly in mortgages, but to have the evidence in one area of the market and not another that should be similarly impacted calls into question the assumptions that it's interest rates driving that. Particularly where the only place globally upholding the "low interest rates = high equity multiples" mantra seems to be the U.S.

What's the end game to free money?
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 03, 2019, 03:13:04 PM
What's the end game to free money?

Scorpioncapital,

I [naturally] can't quantify it, but I suppose it'll be unpleasant for somebody - perhaps very. If I knew how to play it, I would certainly do. But I don't.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 03, 2019, 06:03:33 PM
The problem is not the interest rates or yield curve. Banks can lend at zero rates in Europe because they assume the ECB will cover defaults.

Banks in the US know the Fed is not going to cover defaults. So they have to charge a high enough NIM to generate income to account for defaults. WaMu, Wachovia, Lehma, Bear, and many other bank shareholders/bondholders lost money in 2008. There is market discipline here. US banks have to generate enough income to be able to handle defaults, there is a free market in the US.

In Europe, Draghi is a hero. "Whatever it takes" for the "European Project." Rent freezes in Germany to curtail 10% housing inflation?

"Whatever it takes" means it is OK for the ECB to buy up all defaulting homes in a recession. Why would a borrower who can make payments pay in such a scenario? Everyone would default.

(A 1% NIM is fine if default rates are 0, or if the recovery rate is 100% - e.g. high downpayments. OTOH if default rate is 10%, a 5% NIM is not going to save you. US banks set 20% downpayment with high NIM, European banks have interest-only loans and don't care.)

It s easy to bash the European bankers and the ECB, but what will happen to US banks and US insurance companies  when interest rates go the way they did Europe? US bank8ng has structurally less competition so it might be a bit better, but overall, I would expect NIM to compress to near European levels, which probably means ROE<10% and compressing P/tangible book <1.

The US still has a profitable credit card busInes and other niches that don’t exist in Europe, but banks have non-bank competitors in those.
 Insurers like BHF or LNC with long tail business or even FFH and BRK will be affected as well. Then we have issues with pension fund’s (Hello IBM, GE and many others).

The winners are probably utilities (unless their guaranteed returns gets revised down, as happened in Switzerland ), real estate, infrastructure  and probably solid growth business with or without capital needs that will command higher multiples.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 03, 2019, 06:15:30 PM
I think the reason is the Central Providers at the European Collectivism Bank (ECB) will buy homes at 120% of market value in a recession.

Banks lend to homeowners at negative interest rates without bothering about credit risk. In normal banking, they would have to charge a sufficiently high interest rate to compensate for default rates.

But the European Collectivism Bank provides everything - lavish pensions to whoever needs it by buying Greece 10-year at 2.1%, Italian 2-year at 0%.

At the current time, the Central Providers have bought corporate bonds, but it would be a stretch for the Central Providers to enrich stock market "speculators".

If you interview for a job at a European bank, make sure you say you don't know the meaning of the term "credit risk"

TwoCities, my opinion is that interest rates are more tightly coupled to real estate than equities.  It's standard practice to borrow to buy a house, quite rare in fact not to use debt.  With equities it's much less common to use debt and really it's a dangerous thing to do.   Maybe it's just that simple?  I agree that if markets are efficient there shouldn't be such a divergence but perhaps markets aren't that efficient.

I'm not so certain.

Sure most people don't use debt to buy equities, but the equities themselves have every opportunity to to lever up, refinance at lower rates, acquire competitors, fund capital projects, etc to grow revenues and earnings.

I agree the effects might become more apparent more quickly in mortgages, but to have the evidence in one area of the market and not another that should be similarly impacted calls into question the assumptions that it's interest rates driving that. Particularly where the only place globally upholding the "low interest rates = high equity multiples" mantra seems to be the U.S.

What's the end game to free money?

I think the end game is some hedge fund hotshots like Michael Burry or Paulson getting rich via CDS or other derivatives.

If we really have a "global recession" like the news media claims, will the Greece 10-year yield remain at 2%?

Maybe the Euro falls hard or the CDS goes up? How do I find such a hedge fund to invest in?
Title: Re: Negative interest rates take investors into surreal territory
Post by: mcliu on July 03, 2019, 06:31:46 PM
What a crazy situation.. Doesn't the entire financial system just feel like a ponzi scheme?

Central banks seem to be trapped into a position where they need to
consistently lower interest rates (in-order to stimulate asset prices) so people feel wealthier (and will keep spending).

At this point, is fundamental analysis even relevant? It almost makes sense to keep buying homes/stocks/bonds/assets at ever higher prices because the system cannot tolerate a drop in prices (which will inevitably lead to a "politically unacceptable" recession/depression..)

Also, another perspective: Are the elevated home prices a reflection of growing value for homes (as derived from higher incomes, population, etc.)?
or are they a reflection of the declining value (debasement) of the currency?
Maybe in this modern financial system (and an age of abundance), rapid/hyper inflation is reflected not in the prices of consumer products, but in the prices of financial assets?

No idea. Just thinking out loud.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 03, 2019, 07:11:17 PM
mcliu, This is a European bubble being exported to the US by European investors buying US bonds.
USD/EUR = 0.89.
US government debt is a far far far greater value than any European government debt.

Regarding asset inflation: that is why inflation calculators use "imputed rents", because they can "impute" whatever they please. Housing bubbles don't show up in the CPI.

But the ever-honest Bundesbank revealed that rent inflation in Berlin has been running at 7-10% and some politicians responded with a 5-year rent freeze in Berlin. That is why no Bundesbanker will ever be the head of the ECB. Instead the job of ECB chief is reserved for former or aspiring politicians.

Probably, rent freezes will be put in place in other German cities? Frankfurt rents have also gone up a lot.


What a crazy situation.. Doesn't the entire financial system just feel like a ponzi scheme?

Central banks seem to be trapped into a position where they need to
consistently lower interest rates (in-order to stimulate asset prices) so people feel wealthier (and will keep spending).

At this point, is fundamental analysis even relevant? It almost makes sense to keep buying homes/stocks/bonds/assets at ever higher prices because the system cannot tolerate a drop in prices (which will inevitably lead to a "politically unacceptable" recession/depression..)

Also, another perspective: Are the elevated home prices a reflection of growing value for homes (as derived from higher incomes, population, etc.)?
or are they a reflection of the declining value (debasement) of the currency?
Maybe in this modern financial system (and an age of abundance), rapid/hyper inflation is reflected not in the prices of consumer products, but in the prices of financial assets?

No idea. Just thinking out loud.
Title: Re: Negative interest rates take investors into surreal territory
Post by: SharperDingaan on July 04, 2019, 06:52:47 AM
Just to add some things here ...

It is assumed that lower NIM can be offset with higher fee income. Not really practical.
The advent of CBDC (eKrone), and social media platform currencies (Libra), means fee income has significant low-cost competion. Less fee income.
The mass displacement of large numbers of people in banking is also a social problem. More regulatory management.
....... unusual times, and for quite some time.

It is much harder to change fundamental business practices in Europe/Japan, than it is in the US/Canada. Ability to change.
And if future earnings rely on product innovation in changing times? Lower P/E multiples in Europe/Japan vs US/Canada.
....... 'controlled' bubbles in Europe/Japan as the norm, NOT the exception.

And then there's the UK ....

A Brexit will force widespread and broad change in business practices throughout the UK; unfortunately as a gale clearing out the cobwebs, versus anything 'controlled'. Change that Europe can't do, producing a competitive advantage as innovation is allowed to proceed. Great for the young, not so much for the old.

Average UK P/E multiples should improve over time, but not evenly. High for the new tech firms selling into the UK/Europe, low for the old tech firms stuck with legacy platforms. Betting on old tech firms having innovation failures (the norm) adds additional layers of opportunity. Great for employment, as 7 in 10 'future' jobs  don't exist today.

And the rest of Europe ? ....

Betting against 'moral hazard' is a pretty safe bet, just about everywhere.
There will be well-publicized regular temporary failures accross Europe, but the institution will not be allowed to fail - as too many people depend on its continuation. Over 10yrs+ of wide-spread continual CB interference, Europe has become an addict. Take away the drug, and there are withdrawal reactions. Trading opportunities.

SD
Title: Re: Negative interest rates take investors into surreal territory
Post by: Spekulatius on July 04, 2019, 07:12:55 AM
mcliu, This is a European bubble being exported to the US by European investors buying US bonds.
USD/EUR = 0.89.
US government debt is a far far far greater value than any European government debt.

Regarding asset inflation: that is why inflation calculators use "imputed rents", because they can "impute" whatever they please. Housing bubbles don't show up in the CPI.

But the ever-honest Bundesbank revealed that rent inflation in Berlin has been running at 7-10% and some politicians responded with a 5-year rent freeze in Berlin. That is why no Bundesbanker will ever be the head of the ECB. Instead the job of ECB chief is reserved for former or aspiring politicians.

Probably, rent freezes will be put in place in other German cities? Frankfurt rents have also gone up a lot.


What a crazy situation.. Doesn't the entire financial system just feel like a ponzi scheme?

Central banks seem to be trapped into a position where they need to
consistently lower interest rates (in-order to stimulate asset prices) so people feel wealthier (and will keep spending).

At this point, is fundamental analysis even relevant? It almost makes sense to keep buying homes/stocks/bonds/assets at ever higher prices because the system cannot tolerate a drop in prices (which will inevitably lead to a "politically unacceptable" recession/depression..)

Also, another perspective: Are the elevated home prices a reflection of growing value for homes (as derived from higher incomes, population, etc.)?
or are they a reflection of the declining value (debasement) of the currency?
Maybe in this modern financial system (and an age of abundance), rapid/hyper inflation is reflected not in the prices of consumer products, but in the prices of financial assets?

No idea. Just thinking out loud.

The rising rents in Germany were at least partly caused by immigration. All of a sudden, Germany has 1 Million more people they need housing adding in a short period of time. With full employment and starting with a shortage in larger cities to begin with, and little new construction, it’s easy to see why demand outruns supply. The stop gap measure of rent control certainly will not solve the problem, but make it worse. Adding to the supply is what is needed.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 04, 2019, 09:21:51 AM
Frankfurt home prices grew 15%/year in both 2018 and 2017. So that would be a 32% rise in 2 years.

https://www.dbresearch.com/PROD/RPS_EN-PROD/PROD0000000000460528/The_German_housing_market_in_2018.PDF
https://www.dbresearch.com/PROD/RPS_EN-PROD/PROD0000000000488315/German_property_and_metropolis_market_outlook_2019.pdf

I thought Germany was scared of inflation, but maybe they enjoy housing booms just like anyone else. The author of those DB reports (Mobert) predicted rates rising in 2019 to 0.4% from -0.1%, but instead they have fallen so far in 2019 to -0.4%.


mcliu, This is a European bubble being exported to the US by European investors buying US bonds.
USD/EUR = 0.89.
US government debt is a far far far greater value than any European government debt.

Regarding asset inflation: that is why inflation calculators use "imputed rents", because they can "impute" whatever they please. Housing bubbles don't show up in the CPI.

But the ever-honest Bundesbank revealed that rent inflation in Berlin has been running at 7-10% and some politicians responded with a 5-year rent freeze in Berlin. That is why no Bundesbanker will ever be the head of the ECB. Instead the job of ECB chief is reserved for former or aspiring politicians.

Probably, rent freezes will be put in place in other German cities? Frankfurt rents have also gone up a lot.


What a crazy situation.. Doesn't the entire financial system just feel like a ponzi scheme?

Central banks seem to be trapped into a position where they need to
consistently lower interest rates (in-order to stimulate asset prices) so people feel wealthier (and will keep spending).

At this point, is fundamental analysis even relevant? It almost makes sense to keep buying homes/stocks/bonds/assets at ever higher prices because the system cannot tolerate a drop in prices (which will inevitably lead to a "politically unacceptable" recession/depression..)

Also, another perspective: Are the elevated home prices a reflection of growing value for homes (as derived from higher incomes, population, etc.)?
or are they a reflection of the declining value (debasement) of the currency?
Maybe in this modern financial system (and an age of abundance), rapid/hyper inflation is reflected not in the prices of consumer products, but in the prices of financial assets?

No idea. Just thinking out loud.

The rising rents in Germany were at least partly caused by immigration. All of a sudden, Germany has 1 Million more people they need housing adding in a short period of time. With full employment and starting with a shortage in larger cities to begin with, and little new construction, it’s easy to see why demand outruns supply. The stop gap measure of rent control certainly will not solve the problem, but make it worse. Adding to the supply is what is needed.
Title: Re: Negative interest rates take investors into surreal territory
Post by: mcliu on July 05, 2019, 08:55:23 AM
This feels like a missed opportunity for massive infrastructure investment like what China did since 2008 by building a national high speed railway system.

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.

It just seems like a big investment in infrastructure (high speed rail, internet/fibre/5g, airports) is quite obvious ad it will tighten labour markets, drive wages, increase inflation and interest rates and drive long-term productivity. And the market is basically saying, it'll finance it for next to nothing..

0 high speed rail in the US vs 428km of high-speed rail in China in 2007 to 29,000km in 2017
5 of the 6 top airports in the world are in Asia..
Fastest internet: Taiwan, Singapore, Denmark, Sweden, Japan..
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 05, 2019, 09:04:22 AM

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.


Don't necessarily disagree that some infrastructure spending would be beneficial, but i don't think we should hold out hope that fiscal policy will stoke growth.

There's something called the monetary offset in economics, which basically states that any increased spending on the fiscal side will be cancelled out if the monetary policy target is credible.  I like to think in extremes for though experiments: If we started running a 10% fiscal deficit, but had a 2% inflation target many would worry about upcoming inflation because of large deficits.  But the monetary authorities (in theory) could refuse to finance that deficit and stick with the 2% inflation target.  Default, etc may happen but if a central banks wants to, it can always overwhelm fiscal policy.  This is obviously a bit theoretical and in reality, politics comes into play.  But imo, the more likely real world example is that we don't default but go more the japan route where, despite a huge amount of debt, their low inflation target overwhelms any fiscal deficit/debt they've had. 

Would also note that if we want to stoke growth, imo monetary policy is less wasteful that fiscal policy (fiscal policy risks spending money on things that aren't needed) whereas monetary policy is more evenly distributed and less wasteful
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 05, 2019, 09:16:13 AM
https://www.bloomberg.com/news/articles/2019-07-05/amsterdam-housing-market-gets-some-help-from-dutch-government?srnd=premium

"Construction costs in Amsterdam have risen 25% over the last two years.

median home price in the Dutch capital soared 80% in the past four years to €448,000 ($505,000)."
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 05, 2019, 09:31:00 AM
https://www.bloomberg.com/news/articles/2019-07-05/amsterdam-housing-market-gets-some-help-from-dutch-government?srnd=premium

"Construction costs in Amsterdam have risen 25% over the last two years.

median home price in the Dutch capital soared 80% in the past four years to €448,000 ($505,000)."

Not sure about Amsterdam, but would guess the same applies....

But in New York, SF etc, construction costs (after removing costs from extra studies, etc) are relatively minor compared to final sale price

Its possible to build 40 story apartment buildings for $300/square foot.

However apartments in NYC/SF commonly sell for over $1200/square foot.  Its the constricted supply/air rights/etc that make up much of the cost, and thats only getting worse in SF/NYC (and i presume Amsterdam)

That said, price rises in a certain industry don't imply inflation for an economy as a whole and really don't have anything to do with monetary policy (which is the only way to create long term inflation)

EU and US are very unlikely to see economy wide inflation in the near or medium term, despite rises in prices in certain sectors like housing/health care/, rising oil prices/wage pressure, etc.  The oil price rises in the 1970s, and other "cost push" inflations aren't really what causes inflation. It can put pressure on the monetary authorities to print more money so unemployment doesn't rise, but its ultimately the "printing more money" which causes inflation, not the oil price rise, or the rise in housing prices, etc.

The monetary authorities are too scared of inflation to let it get out of control.  Will likely have to wait for the next generation of central bankers who didn't grow up in the 1970s inflation

edit:  To borrow from Einhorn's analogy...imagine rising oil prices, housing costs, etc as jelly donuts. Imagine the central banks inflation target as your body weight target.  Now housing costs, rising oil prices etc will certainly put pressure on inflation just as eating only jelly donuts will also put adverse pressure on reaching your weight goal.  However it is not the jelly donuts themselves that made you miss your goal weight (Some guy a few years ago actually lost weight eating only twinkies).  Now eating only twinkies/jelly donuts isn't healthy and having rapidly spiking house prices isn't healthy for an economy either (all else being equal).  But it's credibility of "the goal weight" which is paramount. It's the credibility of the inflation target which is paramount. The other stuff (i.e. jelly donuts, oil prices, house prices, etc) is just details.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Spekulatius on July 05, 2019, 10:26:09 AM
This feels like a missed opportunity for massive infrastructure investment like what China did since 2008 by building a national high speed railway system.

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.

It just seems like a big investment in infrastructure (high speed rail, internet/fibre/5g, airports) is quite obvious ad it will tighten labour markets, drive wages, increase inflation and interest rates and drive long-term productivity. And the market is basically saying, it'll finance it for next to nothing..

0 high speed rail in the US vs 428km of high-speed rail in China in 2007 to 29,000km in 2017
5 of the 6 top airports in the world are in Asia..
Fastest internet: Taiwan, Singapore, Denmark, Sweden, Japan..

Yes, it seems kind of crazy in Germany to not do some infrastructure investments (housing, rail etc), because in a lot of cities, the supply hasn’t kept up with demand. Fast rising housing is not popular in Germany because the percentage of homeowners is much lower than in US. Germany had a budget surplus, record low interest rates and demand that can’t be met. I instead of bitching over the negative effect of the immigration , there should be much more focus on making use of it and do what needs to be done. Seem like a no brained to build housing for a million people in cities with job growth, rail infrastructure to meet increased demand and get some of new inhabitants to work at  He same time,  instead of playing financial stimulus that doesn’t seem to do much.

But then again, I am not an economist.
Title: Re: Negative interest rates take investors into surreal territory
Post by: mcliu on July 05, 2019, 10:35:27 AM

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.


Don't necessarily disagree that some infrastructure spending would be beneficial, but i don't think we should hold out hope that fiscal policy will stoke growth.

There's something called the monetary offset in economics, which basically states that any increased spending on the fiscal side will be cancelled out if the monetary policy target is credible.  I like to think in extremes for though experiments: If we started running a 10% fiscal deficit, but had a 2% inflation target many would worry about upcoming inflation because of large deficits.  But the monetary authorities (in theory) could refuse to finance that deficit and stick with the 2% inflation target.  Default, etc may happen but if a central banks wants to, it can always overwhelm fiscal policy.  This is obviously a bit theoretical and in reality, politics comes into play.  But imo, the more likely real world example is that we don't default but go more the japan route where, despite a huge amount of debt, their low inflation target overwhelms any fiscal deficit/debt they've had. 

Would also note that if we want to stoke growth, imo monetary policy is less wasteful that fiscal policy (fiscal policy risks spending money on things that aren't needed) whereas monetary policy is more evenly distributed and less wasteful

The growth isn't necessarily from the spending itself but from the productivity gains that better infrastructure will provide over the long-term.

It's clear that the private sector is more efficient than the government, but there are certain spending and projects that necessarily need government intervention/support.

In addition, markets don't always allocate resources that efficiently either.. The massive housing bubble and excessive investments in real estate is a recent example..

On monetary policy, wouldn't the implementation and transmission may also impact inflation and expectations? Is quantitative easing (buying bonds) the most effective way of printing money vs writing a cheque to everyone vs adding a 0 to everyone's bank accounts?
Title: Re: Negative interest rates take investors into surreal territory
Post by: mcliu on July 05, 2019, 10:44:13 AM
This feels like a missed opportunity for massive infrastructure investment like what China did since 2008 by building a national high speed railway system.

Isn't it interesting that governments aren't using fiscal policy but instead focused on monetary stimulus? Clearly, at this point, monetary policy has had limited effect on driving inflation and wages higher, but may be creating risks in asset price inflation.

It just seems like a big investment in infrastructure (high speed rail, internet/fibre/5g, airports) is quite obvious ad it will tighten labour markets, drive wages, increase inflation and interest rates and drive long-term productivity. And the market is basically saying, it'll finance it for next to nothing..

0 high speed rail in the US vs 428km of high-speed rail in China in 2007 to 29,000km in 2017
5 of the 6 top airports in the world are in Asia..
Fastest internet: Taiwan, Singapore, Denmark, Sweden, Japan..

Yes, it seems kind of crazy in Germany to not do some infrastructure investments (housing, rail etc), because in a lot of cities, the supply hasn’t kept up with demand. Fast rising housing is not popular in Germany because the percentage of homeowners is much lower than in US. Germany had a budget surplus, record low interest rates and demand that can’t be met. I instead of bitching over the negative effect of the immigration , there should be much more focus on making use of it and do what needs to be done. Seem like a no brained to build housing for a million people in cities with job growth, rail infrastructure to meet increased demand and get some of new inhabitants to work at  He same time,  instead of playing financial stimulus that doesn’t seem to do much.

But then again, I am not an economist.

Yes exactly! It just seems so obvious..

All this money printing hasn't driven real productivity or real economic activity. It's just sloshing around the financial system looking for returns and driving up prices. (Not sure why though.. Maybe extreme risk-aversion, uncertainty..?)

It seems like an opportune time for governments to borrow big-time at negative rates and invest in long-term productivity projects..
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 05, 2019, 10:44:40 AM

It's clear that the private sector is more efficient than the government, but there are certain spending and projects that necessarily need government intervention/support.

On monetary policy, wouldn't the implementation and transmission may also impact inflation and expectations? Is quantitative easing (buying bonds) the most effective way of printing money vs writing a cheque to everyone vs adding a 0 to everyone's bank accounts?

No disagreement on the first sentence.  Simply stating that we should do infrastructure spending where its needed logistically etc, not because we hope it will stoke inflation for the economy as a whole.

Imo the transmission mechanism is much less important than the credibility of the target.  if the market doesn't believe the target then it won't stoke inflation.  As an extreme, you could hand out $50,000 to everyone tomorrow but if you promised to tax that same $50,000 out of existence in 1 years time, then imo very little, if any, inflation would result. If forced to choose, i'd stick with the current system of open market operations, it works perfectly fine when the target is clear.  Its only when the target is unclear that we get bloated central bank balance sheets, etc.  Bloated CB balance sheets are a sign of failed monetary policy - expectations have not been managed and money has been too tight.  See: US, ECB, and the most extreme - Japan...Commonly, central banks with the most tight policy have the largest balance sheets.  It's very counterintuitive.

Inflation depends mainly on the expected long term path of the monetary base.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 05, 2019, 11:24:41 AM
Board of Governors of the Federal Reserve System [Released July 5th 2019] : Monetary Policy Report (https://www.federalreserve.gov/publications/files/20190705_mprfullreport.pdf).

Please note on the front cover, top right: "For use at 11:00 a.m. EDT July 5, 2019" - Incidental, huh? [Same day as the job report - just a bit later.]

This report will be presented by Mr. Powell before the Senate Banking Committee as a testimony called "Semiannual Monetary Policy Report to the Congress" on Thursday July 11th 2019 at 10:00 AM.

Summary [p. 1] :


Quote
Economic activity increased at a solid pace in the early part of 2019, and the labor market has continued to strengthen. However, inflation has been running below the Federal Open Market Committee’s (FOMC) longerrun objective of 2 percent. At its meeting in June, the FOMC judged that current and prospective economic conditions called for maintaining the target range for the federal funds rate at 2¼ to 2½ percent. Nonetheless, in light of  increased uncertainties around the economic outlook and muted inflation pressures, the Committee indicated that it will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near the Committee’s symmetric 2 percent objective.

It's exactly the same message as it basically has been for a long time from the FED. -And no talk about rate cuts.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 05, 2019, 06:59:31 PM
There is plenty of inflation right now. This can be proven with a simple exercise. Take the historical CPI reports of the last 10 years for the San Francisco-San Jose-Oakland metro area. In June 2017 this was 1.7%. Assuming an average of 2% for the last 10 years, it compounds to a total of 22% (I don't have the time to dig through all the 10 years of reports, but we don't need to.)

The cost of living in Silicon Valley has more than doubled in the last 10 years. Constructions wages, restaurant wages, tech wages, every kind of private sector wage has doubled or more. Construction costs used to be $150 per square foot earlier this decade, now it is at $350/sqft. Apartment rents have doubled. Home prices have more than doubled. But the inflation reported by the government for this metro area would be a cumulative 25% over the last 10 years.

Another example: If Dutch or German home prices are increasing 10%/year, and housing is 40% of the CPI basket like in the US, home prices alone would contribute 4% to the final inflation figure. Even if the rest of the CPI basket stays flat, we should be seeing 4% inflation. But these crooks use "imputed rents", and "imputed" everything wherever they can. They keep imputing 1-2% in rent inflation.

Then they set monetary policy based on these imaginary "imputed rents." They never measure the inflation in home prices or stock prices or bond prices when justifying their monetary policy. Instead they point to stuff of their imagination - such as "imputed costs", "imputed rents", "hedonic adjustments", "substitution effects" and such other nonsense used in inflation calculations.

I bring this up to help us identify inflection points. When we have misallocation of capital, and things get completely out of wack, the bubble has to pop. Identifying the dislocation before it happens can save or make a lot of money. I don't see how the home price boom can continue in Europe for long while the governments wring their hands about "inflation less than 2%" and keep rates negative. Reality becomes unmoored from the fake inflation figures.


https://www.bloomberg.com/news/articles/2019-07-05/amsterdam-housing-market-gets-some-help-from-dutch-government?srnd=premium

"Construction costs in Amsterdam have risen 25% over the last two years.

median home price in the Dutch capital soared 80% in the past four years to €448,000 ($505,000)."

Not sure about Amsterdam, but would guess the same applies....

But in New York, SF etc, construction costs (after removing costs from extra studies, etc) are relatively minor compared to final sale price

Its possible to build 40 story apartment buildings for $300/square foot.

However apartments in NYC/SF commonly sell for over $1200/square foot.  Its the constricted supply/air rights/etc that make up much of the cost, and thats only getting worse in SF/NYC (and i presume Amsterdam)

That said, price rises in a certain industry don't imply inflation for an economy as a whole and really don't have anything to do with monetary policy (which is the only way to create long term inflation)

EU and US are very unlikely to see economy wide inflation in the near or medium term, despite rises in prices in certain sectors like housing/health care/, rising oil prices/wage pressure, etc.  The oil price rises in the 1970s, and other "cost push" inflations aren't really what causes inflation. It can put pressure on the monetary authorities to print more money so unemployment doesn't rise, but its ultimately the "printing more money" which causes inflation, not the oil price rise, or the rise in housing prices, etc.

The monetary authorities are too scared of inflation to let it get out of control.  Will likely have to wait for the next generation of central bankers who didn't grow up in the 1970s inflation

edit:  To borrow from Einhorn's analogy...imagine rising oil prices, housing costs, etc as jelly donuts. Imagine the central banks inflation target as your body weight target.  Now housing costs, rising oil prices etc will certainly put pressure on inflation just as eating only jelly donuts will also put adverse pressure on reaching your weight goal.  However it is not the jelly donuts themselves that made you miss your goal weight (Some guy a few years ago actually lost weight eating only twinkies).  Now eating only twinkies/jelly donuts isn't healthy and having rapidly spiking house prices isn't healthy for an economy either (all else being equal).  But it's credibility of "the goal weight" which is paramount. It's the credibility of the inflation target which is paramount. The other stuff (i.e. jelly donuts, oil prices, house prices, etc) is just details.
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 05, 2019, 07:24:45 PM
RuleNumberOne,

Not to deflect and I’d be happy to continue this further but the whole shadow stats conspiracy has largely been debunked imo.  Someone a while back even went back and looked at the subscription prices for shadow stats.com and found the dude hadn’t even increased subscription prices at the same rate as his implied super high inflation rate. He increased prices at the much lower rate implying inflation was lower than he guessed.

Scott sumner (who has forgotten more about economics than I’ll ever know) debunked a similar argument as yours from peter Schiff all the way back in 2013 (see video below)

Summers basic point is that if inflation is really as high as you and schiff claim then rgdp would have to be negative or very low.  Something that is very unlikely given the unemployment numbers.  You basically have to believe the government is outright lying across multiples surveys (ngdp, unemployment, etc). Even sp500 revenues do to show anywhere near the inflation your claiming

https://youtu.be/_b4_KuC1-sQ
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 05, 2019, 10:22:45 PM
@JimBowerman

I propose an even simpler exercise for some aspiring economist/intern.

1. Call up 2 real estate agents in the Bay Area, we can get their numbers from mlslistings.com. Ask them:

    -   How much was the construction cost per sqft in 2011? How much is it today? Gone up 2x?

2. Call up 2 apartment complexes in the Bay Area. Ask them:

    -   How much was your rent in 2011? How much is it today? Gone up 2x?

3. Then ask Jim Bullard why the CPI for the San Francisco - San Jose metro area for the last 8 years is so low when rents and home prices went up so much? Housing is > 40% of the US CPI basket.

If housing is 42% of the CPI basket, and rents went up even 7% per year, housing alone would contribute 2.94% to CPI. What tricks did the BLS use to whack it down to 1.5%?

W.r.t your point about S&P revenues, I think S&P domestic revenue fluctuations (both upwards and downwards) have a larger inflation component than government figures (think about it from the viewpoint of bubbles and busts, a chart of S&P sales over time shows this.)

W.r.t your point about rgdp, the gdp figures get revised for many years afterwards because the government has no idea. The gdp figures at any given time are nothing but a guess. The inflation component in nominal gdp is likely larger than what is currently claimed.

BTW, off-topic, but I don't pay any attention to what Sumner/Schiff/shadowstats say. I look at first-hand data myself and come up with first-principle explanations.


RuleNumberOne,

Not to deflect and I’d be happy to continue this further but the whole shadow stats conspiracy has largely been debunked imo.  Someone a while back even went back and looked at the subscription prices for shadow stats.com and found the dude hadn’t even increased subscription prices at the same rate as his implied super high inflation rate. He increased prices at the much lower rate implying inflation was lower than he guessed.

Scott sumner (who has forgotten more about economics than I’ll ever know) debunked a similar argument as yours from peter Schiff all the way back in 2013 (see video below)

Summers basic point is that if inflation is really as high as you and schiff claim then rgdp would have to be negative or very low.  Something that is very unlikely given the unemployment numbers.  You basically have to believe the government is outright lying across multiples surveys (ngdp, unemployment, etc). Even sp500 revenues do to show anywhere near the inflation your claiming

https://youtu.be/_b4_KuC1-sQ
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 09, 2019, 01:12:57 AM
Carried to here from the "1999 again?" topic:


If Danish mortgage rates are at -0.43%, are deposit rates even more negative?

If they are not, on a 30 year mortgage, the bank would lose -13% (since the negative rate is implemented by forgiving -0.43% of the loan every year.)

I really liked that Bloomberg article headline about the stimulus - "won't say when or how." Not sure if the bears will continue to believe there are bullets in Draghi's gun.

The bond bears can make a killing, duration has increased so much that a one percent interest rate increase results in $2.4 trillion in sovereign debt losses alone. Not to mention home price implosion.

You need to understand the Danish mortgage system. It's not financed by deposits, but by mortgage bonds, ref. also what kab60 has mentioned before in this topic.

Here (https://www.rd.dk/PDF/Regnskaber/2018/Aarsrapport_2018.pdf) is link to the 2018 financials for Realkredit Danmark A/S. Realkredit Danmark A/S is a wholly owned subsidiary of Danske Bank A/S. As a mortgage institution, Realkredit Danmark A/S is separately regulated, while the bank is separately regulated as bank.

Please take a look at page 2 - I'll translate for you :


Realkredit Danmark A/S generated a profit for 2018 of DKK 4.649 B [included in the group profit for Danske Bank A/S for 2018]

"Realkreditudlån" : Mortgage loans [for YE2018 : DKK 796.045 B]
"Udstedte realkreditobligationer" : Issued mortgage bonds [for YE2018 : DKK 809.091 B]


- - - o 0 o - - -


Wikipedia : Mortgage industry of Denmark (https://en.wikipedia.org/wiki/Mortgage_industry_of_Denmark).

Edit:

Finance Denmark : The Danish Mortgage Model.
 (http://[/font)
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 09, 2019, 09:14:06 AM
Danske Bank also publishes English statements. They do have deposits, though they also have an equal amount of mortgage bonds.

Either way, this is a forced transfer from bondholders or depositors to homebuyers.

It is like a bondholder buying a house for $2million, selling it to the homebuyer for $1.7 million, and paying the bank $100,000 in commissions.

The cost of this negative rate stuff in creating these distortions is greater than the benefits (I believe a housing bubble is the benefit?). ECB is out of ammo.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Cigarbutt on July 11, 2019, 06:25:27 AM
Surreal may become an insufficient qualitative word at some point:
https://www.ft.com/content/6cee154a-a307-11e9-974c-ad1c6ab5efd1
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 11, 2019, 09:12:02 AM
Finanswatch [July 11th 2019] : Nationalbanken [<- The Danish FED, John] about low interest rates : Not the fault of the central banks (https://finanswatch.dk/Finansnyt/article11495635.ece).

Danmarks Nationalbank [June 27th 2019] : Analysis - The natural real interest rate in Denmark has declined (http://www.nationalbanken.dk/en/publications/Documents/2019/06/ANALYSIS_No%2013_The%20natural%20real%20interest%20rate%20in%20Denmark%20har%20declined.pdf).

Personally, I consider this at least a decent stab at getting to an explanation of this phenomen. It also reminds me of a post recently by Cigarbutt about the long term development in interest rates.

It's not all negatives. The analysis implies, that it - among other things - has to do with high savings rates in the Danish households after the GFC [please note here : at a total level]. Consumption folly [perhaps even for borrowed money] hasn't really arrived here - at least yet.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 11, 2019, 01:50:22 PM
I'm carrying your post in the WFC topic over here, for commentary, RuleNumberOne,


Negative rates have not been proven to work yet. Bernanke and Greenspan have said they don't think it is useful. Bernanke says at some point people will simply hoard cash.

I am not sure how Denmark is forcing people to accept negative rate mortgage bonds. Or how the European Project is forcing people to buy negative rate sovereign debt. As soon as the rate goes negative, one might as well leave their money as cash? Cash is better than any negative rate bond? Unless you force pension funds, university endowments to buy bonds with their cash?

https://www.marketwatch.com/story/alan-greenspan-comes-out-against-using-negative-rates-2016-03-01 (https://www.marketwatch.com/story/alan-greenspan-comes-out-against-using-negative-rates-2016-03-01)
https://www.marketwatch.com/story/bernanke-says-fed-likely-to-add-negative-rates-to-recession-fighting-toolkit-2015-12-15 (https://www.marketwatch.com/story/bernanke-says-fed-likely-to-add-negative-rates-to-recession-fighting-toolkit-2015-12-15)

In Europe, it is probably part of the "whatever it takes" to keep Italy and Greece in the European Project. I haven't seen any explanation of how it benefits the economy.

Europe bond bubble will blow up eventually.

You're certainly up to something right here, RuleNumberOne,

This post is only about Danish conditions.

The answer to your question here is : They don't [buy these bonds with negative yields]. The outcome has been that the Danish banks are literally swimming in cash - some of them are almost drowning in it. The more conservative the bank is run, more worse it gets.

I have read somewhere, that the Danish banks holds retail [household] deposits of ~DKK 900 B. What does a Danish bank do with all its cash, when it gets "punished" by Danmarks Nationalbank [The Danish FED] with an interest rate of minus 0.65 percent if it deposits its liquidity there, when it can't expand its loan underwriting/loan book because of very strict lending policies surveyed by the relentless and pretty brutal Danish FSA with inspections of the loan book, giving orders and fines and such when things aren't done OK? -Furthermore the actual demand for credit from Danish households has been languishing for many years - in general, the Danes have been paying down their debt, and accumulating funds for a rainy day.

The banks only alternative is to buy bonds. So there are large bond positions on the balance sheets of Danish banks - to varying degrees. To at least get some yield from these bonds, the banks have to buy bonds with at least some duration. That again requires capital buffers to withstand [sudden?] rate spikes in the bond market, or else the bank may be forced to reduce its balance sheet [by selling bonds] at the exact wrong time [the price bottom].

- - -  o 0 o - - -

Some data:

So far, I haven't been able to find some data from what I consider a reliable primary source for Danish retail [household] deposits in banks, that I'm sure of, and understand with precision. So here comes a rough, quick & dirty estimate of that figure:

Source:  Danske Bank A/S Factbook Q1 2019 (https://danskebank.com/-/media/danske-bank-com/file-cloud/2019/4/fact-book-q1-2019.pdf).

Deposits [Section 1.7.2 at page 11] :

Retail : DKK 208.0 B
Wealth Management : DKK 70.9 B
Total : DKK 278.9 B

Market share [section 4.1 at page 41] :

Retail : 28.5 percent,

Thus : Total retail [household] deposits in Danish banks ~ DKK 278.9 B / 28.5 percent ~ DKK 978 B

- - - o 0 o - - -

An extreme example of a Danish bank in this situation :

Fynske Bank A/S [ticker : FYNBK.CPH] : [source : 2019Q1 10-K (https://www.fynskebank.dk/globalassets/investor-relations/selskabsmeddelser/fynske-banks-periodemeddelelse-1.-kvartal-2019.pdf)].

Equity : DKK 1,053 M
Loan book : DKK 3,255 M
Deposits : DKK 5,406 M
Bonds : DKK 2,495 M.

Some days I really can't decide if this bank is a bond portfolio with a bank glued to the bond portfolio, or "just" a bank with a big bond portfolio.


- - - o 0 o - - -

The above cash deposits estimate has to be judged relative to total mortgage loans in the Danish mortgage institutions of DKK 1,609 B in Danish homes and recreational homes, plus second layer house financing provided by the banks to households. What matters for the financial stability of the whole system is naturally how these assets and liabilities are distributed among the citizens of the nation.
Title: Re: Negative interest rates take investors into surreal territory
Post by: SHDL on July 11, 2019, 02:31:51 PM
So today (a) the CPI report showed signs of an uptick in inflation, and (b) long term Treasury yields went up following an auction of 30-year bonds that didn’t go so well.  Yes, this could be just noise but they are still interesting data points because they suggest that things might actually be moving in the opposite direction of what a lot of people seem to be expecting.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Cigarbutt on July 11, 2019, 05:32:57 PM
Finanswatch [July 11th 2019] : Nationalbanken [<- The Danish FED, John] about low interest rates : Not the fault of the central banks (https://finanswatch.dk/Finansnyt/article11495635.ece).

Danmarks Nationalbank [June 27th 2019] : Analysis - The natural real interest rate in Denmark has declined (http://www.nationalbanken.dk/en/publications/Documents/2019/06/ANALYSIS_No%2013_The%20natural%20real%20interest%20rate%20in%20Denmark%20har%20declined.pdf).

Personally, I consider this at least a decent stab at getting to an explanation of this phenomen. It also reminds me of a post recently by Cigarbutt about the long term development in interest rates.

It's not all negatives. The analysis implies, that it - among other things - has to do with high savings rates in the Danish households after the GFC [please note here : at a total level]. Consumption folly [perhaps even for borrowed money] hasn't really arrived here - at least yet.
That was an interesting read and it seems to fit with consensus thinking among central bankers with, for example, Mr. Bernanke suggesting over the years that real yields are getting lower in developed countries because of maturing age cohorts and search for yield coming from the savings glut.
Just like deflation I guess, there could be 'good' and 'bad' reasons behind low interest rates.

When people try to get to the top of Mount Everest, gradually declining oxygen levels tend to send a signal to the hiker that the safe limit has been reached, necessitating to abandon the cherished goal. Interestingly, at some point, there is a phase when low levels of oxygen causes cerebral edema and confusion and the safety signal is lost and, without proper sherpa people restraint, people become filled with overconfidence and think they can reach the top at a time when they should retreat. Maybe the sky is the limit.

If interested, Hoisington Investment Management, which used to be a significant source of inputs for Fairfax, released yesterday their Q2 report. They continue to think that yields are heading, eventually, lower.
www.hoisingtonmgt.com/pdf/HIM2019Q2NP.pdf
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 11, 2019, 07:41:09 PM

That was an interesting read and it seems to fit with consensus thinking among central bankers with, for example, Mr. Bernanke suggesting over the years that real yields are getting lower in developed countries because of maturing age cohorts and search for yield coming from the savings glut.
Just like deflation I guess, there could be 'good' and 'bad' reasons behind low interest rates.

Money is neutral in the long run...That is, over the long run, nominal interest rates don't affect real variables.

That said, as Scott Sumner says, in the short and medium term, nominal shocks have real effects (because of sticky wages) so imo the main argument should be to keep nominal growth rates as stable as possible (which central banks have failed miserably at over the last 20 years)

When looking at nominal growth rate stability (and its correlation to real growth rates) I have to believe we can do better

That said, yes, real growth rates (because of slower population growth) should be lower going forward...but that's no excuse for lower nominal growth rates nor more volatile nominal growth rates going forward (both of which a central bank almost completely controls)

https://twitter.com/SplitRockMgmt/status/1147275457324376064
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 11, 2019, 08:00:07 PM
If I were to run a bank in a negative-rate economy, I would not make any mortgages.

I would just keep the deposits in a -10bp fee account, where the 10bp pays for expenses and profits. On 900billion, that is 900 million per year.

All that the bank would do is accept direct deposits of paychecks, wire transfers, checks. It would also provide ATMs for a fee.

The above setup is very profitable. No loan risk, just a nice fee like Visa/Mastercard. If you want, don't even call it a bank. Call it a cash management company.

I presume the government in a negative-rate economy has to force banks and insurance companies, pension funds to buy bonds and make loans. Kind of like a dictatorship, otherwise the economy would look worse than the Great Depression.


I'm carrying your post in the WFC topic over here, for commentary, RuleNumberOne,


Negative rates have not been proven to work yet. Bernanke and Greenspan have said they don't think it is useful. Bernanke says at some point people will simply hoard cash.

I am not sure how Denmark is forcing people to accept negative rate mortgage bonds. Or how the European Project is forcing people to buy negative rate sovereign debt. As soon as the rate goes negative, one might as well leave their money as cash? Cash is better than any negative rate bond? Unless you force pension funds, university endowments to buy bonds with their cash?

https://www.marketwatch.com/story/alan-greenspan-comes-out-against-using-negative-rates-2016-03-01 (https://www.marketwatch.com/story/alan-greenspan-comes-out-against-using-negative-rates-2016-03-01)
https://www.marketwatch.com/story/bernanke-says-fed-likely-to-add-negative-rates-to-recession-fighting-toolkit-2015-12-15 (https://www.marketwatch.com/story/bernanke-says-fed-likely-to-add-negative-rates-to-recession-fighting-toolkit-2015-12-15)

In Europe, it is probably part of the "whatever it takes" to keep Italy and Greece in the European Project. I haven't seen any explanation of how it benefits the economy.

Europe bond bubble will blow up eventually.

You're certainly up to something right here, RuleNumberOne,

This post is only about Danish conditions.

The answer to your question here is : They don't [buy these bonds with negative yields]. The outcome has been that the Danish banks are literally swimming in cash - some of them are almost drowning in it. The more conservative the bank is run, more worse it gets.

I have read somewhere, that the Danish banks holds retail [household] deposits of ~DKK 900 B. What does a Danish bank do with all its cash, when it gets "punished" by Danmarks Nationalbank [The Danish FED] with an interest rate of minus 0.65 percent if it deposits its liquidity there, when it can't expand its loan underwriting/loan book because of very strict lending policies surveyed by the relentless and pretty brutal Danish FSA with inspections of the loan book, giving orders and fines and such when things aren't done OK? -Furthermore the actual demand for credit from Danish households has been languishing for many years - in general, the Danes have been paying down their debt, and accumulating funds for a rainy day.

The banks only alternative is to buy bonds. So there are large bond positions on the balance sheets of Danish banks - to varying degrees. To at least get some yield from these bonds, the banks have to buy bonds with at least some duration. That again requires capital buffers to withstand [sudden?] rate spikes in the bond market, or else the bank may be forced to reduce its balance sheet [by selling bonds] at the exact wrong time [the price bottom].

- - -  o 0 o - - -

Some data:

So far, I haven't been able to find some data from what I consider a reliable primary source for Danish retail [household] deposits in banks, that I'm sure of, and understand with precision. So here comes a rough, quick & dirty estimate of that figure:

Source:  Danske Bank A/S Factbook Q1 2019 (https://danskebank.com/-/media/danske-bank-com/file-cloud/2019/4/fact-book-q1-2019.pdf).

Deposits [Section 1.7.2 at page 11] :

Retail : DKK 208.0 B
Wealth Management : DKK 70.9 B
Total : DKK 278.9 B

Market share [section 4.1 at page 41] :

Retail : 28.5 percent,

Thus : Total retail [household] deposits in Danish banks ~ DKK 278.9 B / 28.5 percent ~ DKK 978 B

- - - o 0 o - - -

An extreme example of a Danish bank in this situation :

Fynske Bank A/S [ticker : FYNBK.CPH] : [source : 2019Q1 10-K (https://www.fynskebank.dk/globalassets/investor-relations/selskabsmeddelser/fynske-banks-periodemeddelelse-1.-kvartal-2019.pdf)].

Equity : DKK 1,053 M
Loan book : DKK 3,255 M
Deposits : DKK 5,406 M
Bonds : DKK 2,495 M.

Some days I really can't decide if this bank is a bond portfolio with a bank glued to the bond portfolio, or "just" a bank with a big bond portfolio.


- - - o 0 o - - -

The above cash deposits estimate has to be judged relative to total mortgage loans in the Danish mortgage institutions of DKK 1,609 B in Danish homes and recreational homes, plus second layer house financing provided by the banks to households. What matters for the financial stability of the whole system is naturally how these assets and liabilities are distributed among the citizens of the nation.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 14, 2019, 11:05:31 PM
This is the Second Tulip Bubble. Investors trading paper at higher and higher prices.

https://www.wsj.com/articles/oxymoron-alert-some-high-yield-bonds-go-negative-11563096601?mod=hp_listb_pos3
"“And just because something is negative yielding, that doesn’t mean it can’t get more negative yielding.” Falling yields mean rising bond prices and gains for investors, at least on paper."

I expect to have a high-yield company issue a negative-yielding bond,” said Martin Reeves, head of high yield at Legal & General Investment Management."


Why don't these investors trade my paper: bonds issued by my Smoke Weed All Day Inc. are rated AAAAA++. The money lent by investors goes straight into an escrow account from where it will be refunded upon maturity. Safer than Treasuries, you never have to worry about entitlement spending.

We don't touch any of the principal. We just use the -0.01% interest to buy weed and smoke it, thereby stimulating the farming economy hurt by the trade war and also raising GDP.

If you get in on the ground floor of -0.01% yield, you may be able to trade it all the way up to a yield of -10% in the coming weeks.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 15, 2019, 07:39:28 PM
https://www.ft.com/content/f176544a-a6ee-11e9-b6ee-3cdf3174eb89

"The fall in yield has pushed the gap between seven-year Greek and German debt — seen as a key barometer of the perceived risk of holding the paper — to around 1.8 percentage points, from 4 points late last year."

Are spreads between Greek and German debt headed to 0?
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 16, 2019, 10:15:45 AM
Everyone seems to think that low nominal yields imply "free money" or "central bank manipulation", but let's look at some historical data and see if there's really any difference between say 1960-2005 vs 2005-2018.  At least compared to the pre 2005 era, have central banks really started printing more "free money" since 2005?

From 1915 to 2000, US nominal GDP averaged about 6.75% and 10 year bond yields averaged 5.5% or so.  Given 4% or so NGDP going forward, are 2.5% bond yields really implying "Free money"?  Or these low yields simply a continuation of the pattern of bond yields averaging a bit less than expected NGDP growth going forward? I'd argue it's the latter....

Next let's look at Germany. German NGDP averaged about 8.5% from 1960 to 2005. During that time, German 10 year bonds averaged about 6.75%. Since 2005, German NGDP has averaged a paltry 3.0% with German bond yields averaging about 2.25% during that time frame. If anything one could argue that German NGDP will be lower than even 3% going forward, so the 0% bond yields don't seem extremely out of the ordinary. Possibly a bit low, but given other EU bank regulations etc, it's far from abnormal.  What would be abnormal is significantly higher German bond yields given the unlikelihood of higher German NGDP going forward.  If folks are going to argue for higher German bond yields, then first they need to explain why German NGDP will be higher going forward. 

In my opinion the ECB has shown few (if any) signs that they desire higher NGDP growth going forward, making the low EU yields about right in my opinion. 

Far from "Free money", the low EU yields accurately reflect the low EU NGDP expectations going forward
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 16, 2019, 07:54:44 PM
Great article about how negative rates in Europe benefit only bond investors but hurt everything else:

https://www.ft.com/content/395f450c-a3be-11e9-974c-ad1c6ab5efd1

"The soft patch in Europe has investors clamouring for the ECB to act — yet not one of those same investors believes interest rate cuts or quantitative easing will have a beneficial impact.

Aside from throwing a festival for fixed-income investors there appear to be very few benefits and high risks from ECB action. Central banks are obsessed with credibility and power. They may not be able to turn a blind eye to a slowdown, but do they really want to reveal the impotence of their current policy tools?"

Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 16, 2019, 08:21:05 PM
The central providers are fond of warning us about $1.3 trillion in leveraged loans.

What happens when the $13 trillion in negative-yielding debt threatens to unwind?
Title: Re: Negative interest rates take investors into surreal territory
Post by: Spekulatius on July 17, 2019, 03:46:27 AM
The central providers are fond of warning us about $1.3 trillion in leveraged loans.

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Cigarbutt on July 17, 2019, 04:36:03 AM
^Whether one is expecting a greater fool or forced by a central authority, it seems that this is fertile ground for an imbalance.
https://gallery.mailchimp.com/7372687636bfa669f0a51ec26/files/3ee5faf6-38fe-412b-9305-83fcbc417eb2/2019_07_04_Betting_Against_The_Gods_Is_Now_Impossible_Charles_Gave.pdf

With the recent ECB nomination and the expected push for more easing and further dive into negative territory, it looks like Europe is following Japan in its path.
https://www.inflation.eu/inflation-rates/japan/historic-inflation/cpi-inflation-japan.aspx

A few days ago, the BIS released their half-year report:
https://www.bis.org/publ/arpdf/ar2019e1.htm
It's long and boring but I think the take-away message is the following:
"The room for policy manoeuvre to address these risks has narrowed since the Great Financial Crisis (GFC) of 2007-09, and regaining it has proved harder than originally thought. One example is monetary policy. After shoring up the economy during the GFC, with other policies taking a back seat, central banks were instrumental in supporting the subsequent recovery. While central banks succeeded, an inflation rate stubbornly below objectives even with economies seemingly operating close to potential has made it harder to proceed along the normalisation path. In addition, after the prolonged period of plentiful accommodation, financial markets have proved very sensitive to signs of policy tightening while some financial vulnerabilities have emerged. As a result, intertemporal trade-offs have come to the fore. The continuation of easy monetary conditions can support the economy, but make normalisation more difficult, in particular through the impact on debt and the financial system. The narrow normalisation path has become narrower."
Isn't value investing about intertemporal trade-offs?

Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 17, 2019, 05:33:15 AM
^Whether one is expecting a greater fool or forced by a central authority, it seems that this is fertile ground for an imbalance. ...

I think the same way as you do, Cigarbutt,

Short/medium term, perhaps this starts as a large liquidity event, also ref. Spekulatius.

Here is a piece, that covers my state of mind recently, related to this phenomena : Scott Galloway : "Earth vs. the Universe" (https://www.profgalloway.com/earth-vs-the-universe?utm_source=newsletter&utm_medium=email&utm_campaign=NMNM2019-07-12).

[Not that is helps much, though. Watering my roses etc. doesn't help either. Nor does mowing the lawn - despite that, it's on the to do list for this afternoon.]
Title: Re: Negative interest rates take investors into surreal territory
Post by: Jurgis on July 17, 2019, 06:28:41 AM
The central providers are fond of warning us about $1.3 trillion in leveraged loans.

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

"when everyone runs for the exit" for negative interest rate loans is no different from "when everyone runs for the exit" for the positive interest rate loans.

Also if rates go up, it doesn't matter whether the bond you held was at -1% and rate went to 1% or if it was at 1% and rate went to 3%. You gonna have comparable losses (well, the math is more complicated for detail obsessed, but you get the drift).
 
Also if negative rate loan is discounted enough, it turns into a positive rate loan on YTM.
Title: Re: Negative interest rates take investors into surreal territory
Post by: SharperDingaan on July 17, 2019, 06:57:10 AM
You might want to step back and look at this a little differently ......

What is the practical limit to monetary policy?
Most would argue when sovereign debt (no credit risk) trades at a 0% YTM - simply because 'they', have to pay 'you' to hold their bond.
But in Europe, there are multiple sovereigns within the EU, of different credit quality; and none of those sovereigns will get to 0%, because we will cut the price of each sovereigns bond first (ie: Greek vs German bond). So ... track the the price difference on benchmark Greek vs German sovereign bonds, and look for when it sudddenly starts widening.

Why is there no fiscal policy response?
We know that borrowed money can be either helicoptered into circulation (monetary policy), or spent on public works. Yet apparently there is no infrastructure (around the world) worthy of rebuilding?, and no insurance/pension funds (around the world) looking to earn more on the fixed income portfolios - than that currently available on sovereign debt?

Because if we think there are projects, this lack of a fiscal response must be because the monetary to fiscal policy transfer mechanisms are either frozen(CB's), or broken. If they are not working, why not?

We would suggest CB capture .... and that it can be exploited.

SD


 
Title: Re: Negative interest rates take investors into surreal territory
Post by: mcliu on July 17, 2019, 08:07:04 AM
The central providers are fond of warning us about $1.3 trillion in leveraged loans.

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

Can negative-rate loans default? Wouldn't the company just refinance at even lower rates? Maybe even negative-coupons?

It's clear that monetary policy is reaching is limits in effectiveness. Rates are below zero without significant effect on economic growth and inflation.

SD makes a good point, it is interesting that there's been such a lack of fiscal response..
Title: Re: Negative interest rates take investors into surreal territory
Post by: Spekulatius on July 17, 2019, 08:26:09 AM
^ Negative loans still have amortization as main cash expense for the  borrower, so default is possible.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 17, 2019, 08:36:09 AM
Or some existing bonds may have run up above face value, so there may still be a positive nominal interest rate on them, that has to be paid. Example : Danish State bonds (https://borsen.dk/investor/kurser/statsobligationer/). [There aren't many in circulation though - some DKK 500 M, because Denmark does not run at a deficit].

- - - o 0 o - - -

Some bond investors have made serious money in this environment - till now.
Title: Re: Negative interest rates take investors into surreal territory
Post by: mcliu on July 17, 2019, 08:53:33 AM
^ Negative loans still have amortization as main cash expense for the  borrower, so default is possible.

Yes but if a borrower needs cash to pay for their principal amortization, can't they can just borrow more? And if they need more cash to repay those debts (interest/principal), they can borrow even more.. so on and so forth.. Doesn't that make default impossible. Hence, the term zombie firms?

So in order to default, you would need a liquidity crunch.. However, central banks are suggesting that if you want to borrow, they will lend. So they are effectively guaranteeing liquidity.
Title: Re: Negative interest rates take investors into surreal territory
Post by: JimBowerman on July 17, 2019, 09:13:11 AM

With the recent ECB nomination and the expected push for more easing and further dive into negative territory, it looks like Europe is following Japan in its path.
https://www.inflation.eu/inflation-rates/japan/historic-inflation/cpi-inflation-japan.aspx


imo Europe (and Japan to a greater extent) hasn't changed the 2050 supply of MB, they've just front loaded the money printing which leads to bloated central bank balance sheets but persistently low inflation.  The market has sniffed this out, called the central banks bluff and,the markets have won.

I don't see any long term change in ECB policy and short a drastic change in politics, don't see inflation rising.

Far from an "expected push for more easing", when you look at the anemic NGDP growth in Japan and EU, you see that monetary policy has instead been overly restrictive and tight - and likely to remain so in the future.

Japan stating their target for the JGB is 0% only tightens monetary policy further...the exact opposite of what the bank of Japan wants.

Should note that unhelpful comments from the U.S. regarding the almost useless term of "currency manipulation" also makes any sort of needed devaluation in Japan and EU very unlikely in my opinion.  The market knows all this
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 17, 2019, 09:20:56 AM
Charles Gave is the new Warren Buffett, he tells you everything you need to know about negative rates. Cigarbutt's "mailchimp" link held this treasure from Charles Gave:

"One day he was called by a
pension regulator at the central bank and reminded of a rule that says funds
should not hold too much cash because it’s risky; they should instead buy
more long-dated bonds. His retort was that most eurozone long bonds had
negative yields and so he was sure to lose money. “It doesn’t matter,” came the
regulator’s reply:
“A rule is a rule, and you must apply it.”

Back in May 2016, an institutional investor bought a five-year zero coupon
bund at €103. Five years on, the bond will be repaid at €100, generating a loss
of €3. How this loss appears will depend on the type of investor in question:
• Pension fund. The €3 loss will reduce the market value of assets by €3.
Holland also has a rule that pension funds must buy more government
bonds the closer they get to being underfunded. Yet buying such
negative-yielding bonds and keeping them to maturity ensures losses,
making it more likely the fund will be underfunded, and so forced to buy
more loss-making bonds (spot the feedback loop)


Bank. As a leveraged player, let’s assume it lends a fairly standard 12
times its capital. This capital has to be invested in “riskless” assets that
are always liquid. As a result, banks are loaded up with bonds issued by the
local state. Now let us assume that a bank has just lost €3 on the zerocoupon bond mentioned above. The bank’s capital base will be reduced by
€3. Based on the 12x banking multiplier, the bank will have to reduce its
loans by a whopping €36 to keep its leverage ratio at 12.


Insurance company.  A standard solution is to cover the
maximum amount of risk with a government bond of similar duration to
the client’s contract period, and then put the remainder into equities or
real estate to help build up the firm’s capital base.
This gets very difficult when government bonds offer negative yields.
Simply put, either the insurance company’s
clients will pay the negative rates, or the company itself will do so
by
increasing its risks without raising returns. This means that either the
client pays more for insurance, and so becomes less profitable, or the
insurance company takes a hit to its bottom line."
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 17, 2019, 09:37:47 AM
Fiscal policy is impossible: German taxpayers are not going to pay Greek pensions.

Draghi has to keep the treadmill (aka bond market momentum aka negative yields) going faster. The faster it goes the harder the crash when momentum reverses. The ECB is made up of charlatans who have blown a big fraudulent bubble.

The US quickly cleaned up the bad bank assets, liquidated many large banks, strengthened the capital base of remaining banks, all this to get them lending.

The European Charlatan Bank has done the reverse: cover up fraudulent accounting and bad assets, bailout everything in sight, erode banking capital base with negative rates and forced bond purchases.

They are still in trouble, no change in debt to GDP in troubled countries, just more debt and a housing bubble in Germany, Netherlands, etc.
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 17, 2019, 11:22:25 AM
...The European Charlatan Bank has done the reverse: cover up fraudulent accounting and bad assets, bailout everything in sight, erode banking capital base with negative rates and forced bond purchases. ...

It's beyond my comprehension, that you continue this line of posting here on CoBF, RuleNumberOne. You are just back in "your old plow furrow" with rambling name-calling & undocumented claims, while simultaneously, you have already exposed your ignorance with regard to European banks and their regulation.
Title: Re: Negative interest rates take investors into surreal territory
Post by: SharperDingaan on July 17, 2019, 11:40:10 AM
"Fiscal policy is impossible: German taxpayers are not going to pay Greek pensions. "

This is an example of CB capture ...
Germans paying greek pensions executes as monetary policy, not fiscal policy.
Were it to execute as fiscal policy; Germans would fund the build and lease-back of greek airports/seaports/toll highways/etc - collect the annual lease payments, and let Greek workers pay into their pension plans. Germans would receive real (state-of-the-art, & earning) assets as collateral, as well as a reduction in the Greek pension fund liability (Greek workers paid some more $ in). And all in addition to less Greek default risk, as better Greek infrastructure facilities increases tourism and related cashflow. Yet, despite lots of very smart people in both Germany, and Greece - this just doesn't happen?

Our own thoughts are that it doesn't happen in a Germany, because there are aren't enough trades workers.
Fiscal policy would cause wage and CPI inflation, but the resultant rise in interest rates would cause asset deflation - and the value of risk weighted banking assets to collapse. Fewer banks, lots of unemployable workers (not trades) on the streets, and most of the 'trades' new wealth being remitted home versus kept in the country. Not great for social stability either.

Instead, we get interesting times.

SD


 
Title: Re: Negative interest rates take investors into surreal territory
Post by: SHDL on July 17, 2019, 12:12:59 PM
The central providers are fond of warning us about $1.3 trillion in leveraged loans.

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

This was in the news yesterday:

https://www.bloomberg.com/news/articles/2019-07-16/a-leveraged-loan-collapses-and-reveals-key-risk-in-credit-market

It's an obscure story that has not been widely reported, but probably worth noting because this is how these things tend to start.
Title: Re: Negative interest rates take investors into surreal territory
Post by: SHDL on July 17, 2019, 12:49:21 PM
Also, see this for some general background on CLOs:

https://www.bloomberg.com/opinion/articles/2019-03-03/collateralized-loan-obligations-are-riskier-than-most-realize

I must say, this looks pretty bad...
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 17, 2019, 11:27:34 PM
We need just a 1% increase in yields for $2.4 trillion in sovereign-debt losses because investors have been forced (some of them by regulators) to swallow long-bonds at zero/negative rates (Austria 100-year at 1%, Swiss 2064 expiry at 0%, and so on). Greece 10-year yields less than US 10-year!!! So far, its been a great ride as bond prices go past the stratosphere.

https://www.bloomberg.com/news/articles/2019-06-26/trillion-dollar-monster-lurks-as-bonds-price-out-duration-risk

"But just look at the math. The Macaulay duration on a Bloomberg Barclays sovereign-debt index is near a record high of 8.32 years, meaning just a one-percentage-point increase in yields would equate to more than a $2.4 trillion loss.

One measure of the relative compensation investors receive to hold longer-dated obligations is a whisker away from a 58-year low. Over in Europe, they’re taking a century of risk for yields barely above 1% in order to escape a $13 trillion global stockpile of negative debt.

All that is leaving duration, a measure of sensitivity to interest-rate changes, near all-time highs across sovereign debt markets.

One gauge of the compensation investors demand to hold longer-term Treasuries versus rolling over short-dated obligations, known as the term premium, is near record lows -- underscoring the intense conviction in the low-rate, lowflation era in markets. Over in Europe, the ask yield on Swiss bonds due 2064 even fell below zero percent last week."


The central providers are fond of warning us about $1.3 trillion in leveraged loans.

What happens when the $13 trillion in negative-yielding debt threatens to unwind?

I am waiting for the day when a couple of negative interest rate loans default. If indeed momentum and hope for capital gains (betting on negative interest rates becoming more negative) is the driving force, then everyone knows it’s a fools game and jut hopes they can sell before the rest does and once momentum turns, things could get rather strange when everyone runs for the exit.

Can negative-rate loans default? Wouldn't the company just refinance at even lower rates? Maybe even negative-coupons?

It's clear that monetary policy is reaching is limits in effectiveness. Rates are below zero without significant effect on economic growth and inflation.

SD makes a good point, it is interesting that there's been such a lack of fiscal response..
Title: Re: Negative interest rates take investors into surreal territory
Post by: Cardboard on July 18, 2019, 05:32:00 AM
Dalio says to buy gold:

https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html

Eventually it seems that hard assets become the place to be to protect one from devaluation, default and what you are mentioning RuleNumberOne.

And on top of that, these areas have been abandonned for many years with little capital investment. Certainly the case for the entire commodity complex.

Cardboard
Title: Re: Negative interest rates take investors into surreal territory
Post by: John Hjorth on July 18, 2019, 12:03:48 PM
Dalio says to buy gold:

https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html (https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html)

Eventually it seems that hard assets become the place to be to protect one from devaluation, default and what you are mentioning RuleNumberOne.

And on top of that, these areas have been abandonned for many years with little capital investment. Certainly the case for the entire commodity complex.

Cardboard

What is it, that you're really suggesting here, Cardboard?
Title: Re: Negative interest rates take investors into surreal territory
Post by: SHDL on July 18, 2019, 03:21:41 PM
Also, see this for some general background on CLOs:

https://www.bloomberg.com/opinion/articles/2019-03-03/collateralized-loan-obligations-are-riskier-than-most-realize

I must say, this looks pretty bad...

I got this report in the mail:

https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2019/july-2019.pdf

There is some data and discussion starting on p. 24 on who owns these loans (directly or through CLOs).  Apparently banks own a big chunk of this, which I don’t like.
Title: Re: Negative interest rates take investors into surreal territory
Post by: Cigarbutt on July 18, 2019, 05:15:29 PM
Dalio says to buy gold:

https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html (https://www.cnbc.com/2019/07/17/ray-dalio-says-gold-will-be-a-top-investment-during-upcoming-paradigm-shift-for-global-markets.html)

Eventually it seems that hard assets become the place to be to protect one from devaluation, default and what you are mentioning RuleNumberOne.

And on top of that, these areas have been abandonned for many years with little capital investment. Certainly the case for the entire commodity complex.

Cardboard

What is it, that you're really suggesting here, Cardboard?
I guess part of the answer is expectations related to mean reversion.
https://www.marketwatch.com/story/this-chart-from-gundlachs-doubleline-capital-says-commodities-are-due-to-rally-2018-01-31
Mr. Gundlach who is now financially related to both Mr. Marks and Mr. Flatt has expressed, for some time, that the interest rate 'environment' has contributed to the relative valuation profile and the generational occurrence of the present situation.

What is Mr. Gundlach's opinion about negative interest rates: negative, very negative.  :)
Disclosure: I've held (indirectly) physical gold from 2003 to 2008 and, despite the outcome, decided that the process was wrong and promised never to do it again. I guess, renewed interest in gold (Dalio et al) may have something to do with potential currency debasement.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 18, 2019, 07:37:06 PM
https://www.youtube.com/watch?v=q862lngj034

Buffett on negative rates in the video above:

- "distorts everything"
- "we do not know how this movie plays out"

That video was over 3 years ago.
Title: Re: Negative interest rates take investors into surreal territory
Post by: RuleNumberOne on July 18, 2019, 07:45:39 PM
European Project continues at warp speed as Italian bank sells 7-year collateralized bond at 0.44% yield. Investors from Germany and Austria accounted for more than a third of the allocated orders.
https://www.ft.com/content/c54a4dcc-a892-11e9-984c-fac8325aaa04


Former Bundesbank chief (and former ECB "Governing Council" member) Axel Weber is saying in a different way what Munger said about paying A+B for what ends up as A at the end of the day.

https://www.bloomberg.com/news/articles/2019-07-17/europe-dived-into-negative-rates-and-now-it-can-t-find-a-way-out
“I would never say you cannot go negative, you can do everything for a short time,’’ Axel Weber, chairman of UBS and a former ECB policy maker, said in Zurich this month. “But it’s like diving into water. You can stay under water for some time, you can’t stay there forever.’’