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  #151  
Old 09-19-2019, 03:26 PM
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Mary Pat Campbell
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https://knowledge.wharton.upenn.edu/...ign=2019-09-17

Quote:
Are Negative Interest Rates on the Way in the U.S.?

Spoiler:
First it was former Federal Reserve Chairman Alan Greenspan saying back in August that he sees “no barrier” for U.S. Treasury yields going negative. Then President Trump called on the Fed this month to drive interest rates negative in order to stimulate the economy. While negative rates have been a distinguishing feature of the Japanese economy and many European economies for some years now, the concept has not been a serious possibility in the U.S. until recently.

The concept basically involves a charge to banks for holding reserves. That cost would be intended to spur them to lend more, which — along with lower rates more generally — would presumably drive economic growth. Negative rates on government securities held by the public are another possible scenario. Greenspan told CNBC on September 4 that investors should watch the yield on the 30-year note to see if negative interest rates are in the offing.

Today, there are some $16 trillion in negative government securities worldwide, and the European Central Bank (ECB) on September 12 cut its interest rate 10 basis points to a record low of -0.5% and also ordered a new round of quantitative easing ($20 billion in bond purchases and other financial assets) in November. Such bond buying drives down yields and cuts borrowing costs. The ECB also recommended some spending stimulus for countries — to boost European Union economies.

But while lower interest rates generally can whittle down government debt, they also subtract from the returns earned by banks and individual savers. And when rates turn negative, it is not clear exactly what the bottom-line effects might be long term across the economy. Some observers say negative rates could lead to a slow-growth environment from which it would be difficult to escape. Others contend the overall effect would be to stimulate the economy.

Behind the Trend

But what is driving this trend, and what might it mean for the U.S. economy?

In addition to long-term trends, the immediate cause for the U.S. is likely trade tensions, which have touched off an investor flight to the perceived safety of U.S. government securities. That has pushed interest rates lower. And that all piles on to a longer-term drift downward for rates, long underway and led by a slowing economy. Japan, for example, has had negative rates since 2016.

The slowing of economic growth is sometimes blamed on “secular stagnation,” said Wharton professor of legal studies and business ethics Peter Conti-Brown during a recent segment of the Knowledge@Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)

Secular stagnation has been defined as “a prolonged period in which satisfactory growth can only be achieved by unsustainable financial conditions.” U.S. economic growth, while steady, has been lackluster at a time when the current expansion since the Great Recession is the longest on record. For reasons not well understood, Conti-Brown added, inflation is low despite very low unemployment.

Part of reason for the low-growth economy is demographics — an aging workforce — said Lisa Cook, a professor of economics and international relations at Michigan State University, who also joined the radio show. In agreeing with Greenspan on that point she added, “We have a population that is not only aging but leaving the workforce,” and that is a drag on the economy.

Given the exodus from the workforce, retirees will depend more on their savings, and thus negative interest rates “will have tremendous implications for them,” Cook added. Similar — even stronger — trends are at play in Europe and Japan.

Downward Pressure from Inflation

Typically, when interest rates remain low for a long period, inflation picks up, but this time that is “really not happening,” noted Wharton finance professor Itay Goldstein, on the radio show. It’s time to challenge the “old paradigms” because something structural seems to have changed. At the same time, cheaper money has flowed freely into boosting asset prices, from equities to bonds and real estate, he added. “So maybe this is where we see the effect. But we don’t see it in prices of goods. We don’t see it in inflation.”

“We simply don’t know how markets in the world’s largest economy would respond to this new world.”–Peter Conti-Brown

In any case, the Fed is left today with less power to influence financial markets given that rates are already so low. When rates hit zero, the so-called zero-bound, the Fed’s potential influence is thought to be at the end. Negative rates could change that. Since the Great Recession, lowering rates has not been as effective at stimulating the economy as in the past, and QE has also lost some of its bite. “So, central banks are asking themselves, ‘what can we do?’” Goldstein added. One tool is to cut rates to below zero.

Conti-Brown agreed. He pointed out that Fed chair Jerome Powell admitted that the Fed’s key estimate of “one of the most important indicators — the unemployment rate, that is the so-called ‘natural rate,’ the rate that it should be targeting — has been wrong. And not just wrong, badly wrong.” While unemployment rates kept slipping down, inflation did not budge, unlike what the models predicted. The relationship between inflation and unemployment “seems to be absent without leave.”

Some observers argue that there is an explanation for inflation’s disappearing act, and that is an overall lack of demand that keeps the economy below its full potential productive capacity. Fiscal stimulus is called for, they contend. The problem with that is ideological and political. With budgets deep in the red, and a prevailing mood against adding to debt, more spending would appear to be a non-starter for now.

Conti-Brown explained that one way to think about negative rates is to ask if they would have made any difference during the Great Recession. Had the Fed at the time cut nominal interest rates into “deep negative territory,” he added, “is it conceivable that the recovery would have been much, much faster? Yes, it is. This could be a very potent tool.”

Nevertheless, Conti-Brown added that there remains the question of whether or not the Fed has the legal right to move rates below zero and whether or not institutionally the Fed is capable at the moment of taking what could be viewed by some as such a drastic step. What’s more, political resistance would be strong and the panelists agreed that politics is increasingly important in influencing the Fed’s interest rate policies.

Ample Uncertainty

On top of that, there is a lot of uncertainty about the effect of negative rates. “How will individuals and firms react?” asked Cook. “Will they continue to wait for further rate cuts, will they continue to wait for lower mortgage rates or lower interest rates on their loans…? We don’t know. This is completely new territory.”

Regarding consumers, Cook noted that if banks can’t “make money the traditional way, they’re going to try to make money by [charging] more fees. … This will certainly raise some safety and regulatory issues related to consumers.”

Conti-Brown agreed that it is very difficult to predict all of the results that negative rates would produce. “We simply don’t know how markets in the world’s largest economy would respond to this new world.” Would it lead to “explosive economic growth” or “high inflation that we never expected or … something new that might just be coming our way that we didn’t anticipate?”

“Central banks are asking themselves, ‘what can we do?’”— Itay Goldstein

Another consideration: the effect negative rates might have on the financial system. Banks are used to positive interest rates. “This is how they make their spread. They might face difficulties making money and generating profits in a new world like this,” Goldstein said. If they are charged for putting money with the Fed, and “they can’t necessarily transfer the negative rates to their depositors, that might cause big difficulties for banks.”

Patrick Harker, president of the Federal Reserve Bank of Philadelphia, in a recent Knowledge@Wharton interview, made a related point: “We don’t have a lot of room to move rates.… Moving rates 50 basis points is not going to have a demonstrable effect. Then, it also creates other risks, because there’s a third component of the Fed, not in our dual mandate, but very important — financial stability. There is ample evidence that rates being this low for this long, start to create situations of financial instability….”

Nevertheless, the three panelists agreed that at this point, we are more likely to see negative rates than not.
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  #152  
Old 10-10-2019, 12:39 PM
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GREECE

https://www.ft.com/content/5dde46c4-...KEBOTe_Cf32DUo

Quote:
Greece joins club of negative-yielding debt issuers
Milestone comes alongside new record-low borrowing costs for Portugal
Spoiler:



The list of countries being paid to borrow by investors has an unlikely new member: Greece.

In a rally that has now swept through all corners of the eurozone debt markets, and that also shoved Portuguese borrowing costs down to record lows on Wednesday, the Greek government sold new three-month debt at a negative yield for the first time, meaning buyers were prepared to lock in a loss on their investment.

The milestone caps Greece’s extraordinary rehabilitation in the eyes of investors after it received multiple bailouts during the region’s debt crisis.

Athens raised €487.5m from its auction of 13-week bills at a yield of minus 0.02 per cent, compared with positive 0.10 per cent at the previous sale in August. Bills are a form of short-term government debt generally purchased by banks looking for somewhere to park their cash.

The decline partly reflects the fact that the European Central Bank cut interest rates by 0.1 percentage point to minus 0.5 per cent in September.

But the milestone — along with Tuesday’s sale of €1.5bn of 10-year bonds at a record low yield of 1.5 per cent — is also a sign that investors have grown more confident about the prospects for the Greek economy, which is forecast to grow at 2.8 per cent next year.

With the ECB also announcing the resumption of its bond-buying stimulus programme last month, markets are awash with cash drawn to the relatively high yield that Greek debt offers.

“This is a function of very low interest rates and QE, which begets more risk-seeking behaviour by investors,” said Peter Schaffrik, global macro strategist at RBC Capital Markets. Thanks to the ECB’s stimulus efforts, and gloom about prospects for the global economy, about two-thirds of the government debt in the euro area trades at a negative yield, including all German bonds.

Other former crisis spots such as Italy and Spain have already joined the negative-yield club, with Madrid being paid to borrow to maturities of up to nearly a decade.

Debt sales by Italy and Portugal on Wednesday further underlined the hunger for eurozone sovereign bonds, which is fuelled by bets that interest rate will stay at rock-bottom levels for years to come. Prices in eurozone money markets indicates that investors expect the ECB to hold interest rates below zero for the next seven years.

“If that’s the case, people will continue to grab anything with a bit of yield,” said Iain Stealey, head of international fixed income at JPMorgan Asset Management.

Italy secured more than $18bn of orders for $7bn of five-, 10-, and 30-year bonds as it returned to dollar markets for the first time since 2010. The new 10-year bond was expected to price at a yield just below 3 per cent, about 1.4 percentage points higher than the equivalent US government bond.

Portugal auctioned €750m in 15-year government bonds at a record low yield of 0.49 per cent. Demand for the auction of 15-year bonds was almost 2.5 times the amount on offer.

It was Portugal’s first bond auction since the ruling centre-left Socialists (PS) won a general election on Sunday, increasing their share of the vote, but falling short of an absolute majority.

The yield on the country’s benchmark 10-year debt has also dropped below that of Spain in recent days, a rare occurrence since the Iberian neighbours became eurozone members. Spain is heading towards a general election in November, its fourth in as many years.

The drop in yields, which move inversely to price, came after DBRS lifted Portugal’s debt rating by one notch to BBB (high) on Friday, the highest rating the Canadian rating agency has attributed to the country in eight years.

DBRS said on Monday the outcome of Portugal’s election pointed to a “broad continuity of domestic policies” in a country where “successive governments have shown a strong commitment to tackling economic and fiscal challenges”.

A government official said on Tuesday that Portugal would this month pay back €2bn to the European Financial Stabilisation Fund several years ahead of schedule, saving an estimated €120m in interest payments.

I am completely flummoxed. This is insane.
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  #153  
Old 10-11-2019, 04:24 PM
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GREECE

https://www.wsj.com/articles/greece-...ub-11570640925

Quote:
Greece, Once in Crisis, Joins Negative-Rates Club
Debt-laden country sells bonds yielding less than 0% for the first time
Spoiler:
Greece sold debt offering less than 0% for the first time on Wednesday in the latest sign of how far investors will go in a hunt for returns amid a global slump in yields.

The Greek government issued 487.5 million euros ($535.31 million) of three-month debt at a yield of minus-0.02%. At a previous auction for bills with similar maturity on Aug. 7, the rate was 0.095%.

The move reflects a broader shift in European bond markets in recent years, with investors paying governments from Germany and Switzerland to Italy to hold their money as the European Central Bank cuts borrowing costs to bolster economic growth in the region.

That also means investors are being forced to take on more risk to generate returns, with Greece long considered the final frontier.

The nation, which emerged in August 2018 from an eight-year international bailout program following a prolonged debt crisis, has been welcomed back into the bond market with strong demand for its debt. The falling borrowing costs in recent months are a sign that Greece is steadily becoming just another eurozone country in investors' eyes, after years when its survival in the common currency was in doubt.

"The general monetary-policy environment, not only in Europe but globally, helps issuers that have more debt on their balance sheet," saidAndrey Kuznetsov, senior portfolio manager at Hermes Investment Management. "The weak global macro environment combined with monetary-policy easing and bigger demand for fixed income from an aging population means that to deliver the same return, investors have to take on more risk."

The ECB took its key benchmark further into negative territory last month as it reduced the interest rate by one-tenth of a percentage point, to minus-0.5%.

The monetary authority also launched a sweeping package of bond purchases as concerns about the health of the eurozone economy persist, laying the groundwork for an extended period of easy money.

While the Greek government so far has issued only very short-term debt at a negative yield, other European governments are borrowing through longer-dated debt that pays no interest.

Germany, for example, sold 30-year debt at a negative yield for the first time in August.

The yield on the government debt has tracked improvements in the Greek economy, suggesting that debtholders are "not as worried they're going to lose money as they were in the past," according to Lefteris Farmakis, a strategist at UBS.

Greece's economy has been growing at around 2% a year lately, but remains deeply depressed after shrinking by over one-quarter during its financial crisis.

Under the bailout program, the country was forced to enact drastic fiscal retrenchment in exchange for loans from other eurozone countries and the International Monetary Fund.

The election of a pro-business, center-right government under Prime Minister Kyriakos Mitsotakis this July has further contributed to a sense that normality is returning.

Still, Mr. Mitsotakis's ability to loosen crisis-era austerity by cutting taxes remains constrained by the insistence of Greece's German-led creditors that Athens continue to run budget surpluses.

Doubts remain over the sustainability of Greece's debt in the long term, because its huge, cheap bailout loans from eurozone governments must eventually be replaced with market financing at uncertain cost.

Most investors believe Germany and others won't let Greece fall back into a crisis and will delay the loans' repayment if necessary.

"If Greece continues to do well and credit risk continues to go down, you could see rates go even more negative," Mr. Farmakis said.

Greece's first issuance after exiting the bailout program, in January, saw the debt office attract demand in excess of 10 billion euros for a 2.5 billion euro fundraising round.

Wednesday's issuance comes a day after Greece raised 1.5 billion euros from the sale of its existing March 2029 bonds at a yield of 1.50%. That marked a record low cost for its 10-year debt.

"The weak global macro environment combined with monetary-policy easing and bigger demand for fixed income from an aging population means that to deliver the same return, investors have to take on more risk," Mr. Kuznetsov said.


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  #154  
Old 10-11-2019, 04:24 PM
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GREECE

https://www.wsj.com/articles/greece-...ub-11570640925

Quote:
Greece, Once in Crisis, Joins Negative-Rates Club
Debt-laden country sells bonds yielding less than 0% for the first time
Spoiler:
Greece sold debt offering less than 0% for the first time on Wednesday in the latest sign of how far investors will go in a hunt for returns amid a global slump in yields.

The Greek government issued 487.5 million euros ($535.31 million) of three-month debt at a yield of minus-0.02%. At a previous auction for bills with similar maturity on Aug. 7, the rate was 0.095%.

The move reflects a broader shift in European bond markets in recent years, with investors paying governments from Germany and Switzerland to Italy to hold their money as the European Central Bank cuts borrowing costs to bolster economic growth in the region.

That also means investors are being forced to take on more risk to generate returns, with Greece long considered the final frontier.

The nation, which emerged in August 2018 from an eight-year international bailout program following a prolonged debt crisis, has been welcomed back into the bond market with strong demand for its debt. The falling borrowing costs in recent months are a sign that Greece is steadily becoming just another eurozone country in investors' eyes, after years when its survival in the common currency was in doubt.

"The general monetary-policy environment, not only in Europe but globally, helps issuers that have more debt on their balance sheet," saidAndrey Kuznetsov, senior portfolio manager at Hermes Investment Management. "The weak global macro environment combined with monetary-policy easing and bigger demand for fixed income from an aging population means that to deliver the same return, investors have to take on more risk."

The ECB took its key benchmark further into negative territory last month as it reduced the interest rate by one-tenth of a percentage point, to minus-0.5%.

The monetary authority also launched a sweeping package of bond purchases as concerns about the health of the eurozone economy persist, laying the groundwork for an extended period of easy money.

While the Greek government so far has issued only very short-term debt at a negative yield, other European governments are borrowing through longer-dated debt that pays no interest.

Germany, for example, sold 30-year debt at a negative yield for the first time in August.

The yield on the government debt has tracked improvements in the Greek economy, suggesting that debtholders are "not as worried they're going to lose money as they were in the past," according to Lefteris Farmakis, a strategist at UBS.

Greece's economy has been growing at around 2% a year lately, but remains deeply depressed after shrinking by over one-quarter during its financial crisis.

Under the bailout program, the country was forced to enact drastic fiscal retrenchment in exchange for loans from other eurozone countries and the International Monetary Fund.

The election of a pro-business, center-right government under Prime Minister Kyriakos Mitsotakis this July has further contributed to a sense that normality is returning.

Still, Mr. Mitsotakis's ability to loosen crisis-era austerity by cutting taxes remains constrained by the insistence of Greece's German-led creditors that Athens continue to run budget surpluses.

Doubts remain over the sustainability of Greece's debt in the long term, because its huge, cheap bailout loans from eurozone governments must eventually be replaced with market financing at uncertain cost.

Most investors believe Germany and others won't let Greece fall back into a crisis and will delay the loans' repayment if necessary.

"If Greece continues to do well and credit risk continues to go down, you could see rates go even more negative," Mr. Farmakis said.

Greece's first issuance after exiting the bailout program, in January, saw the debt office attract demand in excess of 10 billion euros for a 2.5 billion euro fundraising round.

Wednesday's issuance comes a day after Greece raised 1.5 billion euros from the sale of its existing March 2029 bonds at a yield of 1.50%. That marked a record low cost for its 10-year debt.

"The weak global macro environment combined with monetary-policy easing and bigger demand for fixed income from an aging population means that to deliver the same return, investors have to take on more risk," Mr. Kuznetsov said.


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  #155  
Old 10-15-2019, 03:59 PM
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https://www.thinkadvisor.com/2019/10...&utm_term=tadv

Quote:
Why Global Bond Yields Are Negative
Why purchase a bond with a negative yield? Do negative yields portend an ominous future?

Spoiler:
Nearly a third of the global sovereign debt market carries a negative yield. Most, but not all, is in Europe. When yields are negative, bondholders do not receive a coupon payment, but pay to own these bonds. This unique environment prompts several important questions.

What causes negative bond yields? Why purchase a bond with a negative yield? Do negative yields portend an ominous future? To help answer these and other questions, I spoke with Strider Elass, Senior Economist with First Trust Portfolios L.P.
Mike Patton: What caused bond yields to turn negative?

Strider Elass: It may be traced to the negative interest rate policies adopted by various central banks. Additionally, in the post-2008 crisis world, many countries believed the way to fix their economies is by lowering rates even further to jump start investment and essentially force banks to lend, yet most of these economies continue to struggle. What ails these economies is not a lack of money, but poor fiscal policies, including high taxes, over-regulation, and high government spending. Yet, nothing is being addressed on the fiscal side. I believe Denmark was the first country to go negative (2012). Much of the rest of Europe followed suite in 2014. Japan’s bond yields turned negative the same year.
Mike: Why would anyone purchase bonds with a negative yield since there is no regular coupon payment?

Strider: It baffles me. Since there is no regular coupon payment, the investor can only make money if the price rises above what they paid for the bond. If investors believe economic conditions will deteriorate further, they will invest more money in these “safe” securities and prices will rise further. This would also cause yields to become more negative. In Europe, knowing the ECB will continue to buy, gives many the idea there is a backstop.

Mike: Since bond prices have risen substantially, is this a bond bubble and if so, what might happen when it bursts?

Strider: Yes, I believe this is a bubble. At some point, when the EU economy recovers, optimism will return. This will likely prompt bond owners to sell and invest in risk assets. Like past bubbles, when it bursts, prices will fall rather quickly (and yields will rise). Investors who are holding these bonds when the bubble bursts will experience a good bit of pain. This could cause the government to step in to alleviate the pain. While we don’t know what specific policies the EU will implement, whatever they do will cost money, making it necessary to issue more bonds. It’s hard to say how this will end.

Mike: How do negative yields affect the government’s that issue this debt?

Strider: This is a benefit for government. For example, assume Country A issues $1 million in debt priced at a premium of $110. The investor pays $1.1 million to purchase it. At maturity, the investor (or whoever holds the bond at that time) will receive par (100) or $1 million. Hence, the government is guaranteed a profit of $100,000 or 10%. Also, low and negative yields make the cost of borrowing very cheap.

Thank you, Strider.

Clearly this is a unique environment as sovereign bond yields remain negative. How it will end is difficult to say. However, this negative rate environment is clearly distorting the fixed income market. In addition, the road to yield (and price) normalization will bring some degree of pain to bondholders. It’s a bit like the game, hot potato. If bond prices rise further, their yield-to-maturity will continue to deteriorate. I wouldn’t want to be caught holding these securities when they mature.


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  #156  
Old 10-16-2019, 09:24 AM
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Thanks for all these threads, MPC (bond yields/pensions/etc). I do follow them pretty often even if generally devoid of comments.
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Old 10-16-2019, 09:42 AM
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I've basically been using the AO as my version of Evernote

Why not share what I find?
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Old 10-16-2019, 01:23 PM
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https://www.bloomberg.com/news/artic...ve-yield-bonds

Quote:
JPMorgan Veteran Refuses to Buy ‘Insane’ Negative-Yield Bonds
By Ruth Carson
October 16, 2019, 6:01 AM EDT
Eigen predicts ‘rough’ slowdown, but still wants to shun bonds
‘The day I buy a negative-yielding security is when I retire’
Spoiler:
Lots of investors chafe at the idea of buying negative-yield bonds. Few are as repelled by the prospect as William Eigen

The JPMorgan Asset Management fund manager says he’d retire before buying sub-zero securities, even as some of his peers profit from the trade amid mounting fears of a global recession. He predicts negative-yielding bonds will eventually lead to “devastating” losses and has parked almost half of his fund in cash that will be insulated from a market sell-off.

“The whole concept of negative yields, of people paying for the privilege of lending money, is insane behavior to me,” Eigen, a 29-year industry veteran who oversees the $12.5 billion JPMorgan Strategic Income Opportunities Fund, said in an interview from Boston. “I do not pay to lend money. That’s not fixed-income investing, that’s fixed-loss investing.”

Eigen says investors will ultimately face a train wreck in a market distorted by vast amounts of negative-yielding debt spurred by years of ultra-loose monetary policy from Europe to Japan. Some $13.4 trillion of securities now trade with sub-zero yields as several European central banks and Japan slashed rates to below zero after the financial crisis in a bid to spur growth.

The measures, including the European Central Bank’s enormous bond-buying program, were meant to be temporary, but Europe’s benchmark rate has persistently stayed below zero since 2014. The value of negative-yielding bonds has surged 61% this year, triggered in part by fears of a prolonged U.S.-China trade war.
Eigen said he’s shunning the debt even as he predicts a recession in Europe and a “pretty rough” slowdown in the U.S., which would normally be a good time to buy bonds
He gave three reasons: bonds are already pricing in bad times. And you can only make a capital gain from negative-yielding debt “if someone crazier than you is willing to come in to pay more for the privilege of lending money to an over-levered government or a company.”

‘ Devastating’ Losses

But most importantly, nothing about the current bond market is sustainable, according to Eigen. Sooner or later, it’s going to crash, and he wants to be there with dry powder when it happens.

“What I’m saying is that you print this much money, you put trillions of dollars of securities on your balance sheet, at some point something’s going to break,” Eigen said. “I’m not saying it’s going to be in the short term, but man, when this thing breaks, the losses fixed-income investors will be facing will be devastating, and it’s my job in that environment to post positive returns.”

Eigen’s fund, which aims to outperform cash, has returned 3.2% in 2019, above the effective Federal Funds rate of 1.75% to 2%. But he’s also trailing behind peers who buy low or negative-yielding bonds: the Bloomberg Barclays Global-Aggregate Total Return Index has gained 6.2% this year .

He’s not alone as bond bears underperformed this year, with even heavy hitters such as Dan Ivascyn’s Pimco Income Fund and Ray Dalio’s flagship investment losing out amid a global rally.

It’s not just sub-zero rates in Europe that are raising Eigen’s wariness. An automotive enthusiast with a penchant for fast Italian motorcycles, he takes his cues on the economy from customers at two commercial garages that he partly owns in central Massachusetts. Eigen’s not liking what he’s hearing as the 2020 presidential election draws near.

Nervous Customers

“I see some of our bigger buyers and the bigger customers getting really nervous,” he said. Elections “have become so polarized here in the U.S. that that can’t be good for confidence, and confidence drives the economy.”

The cocktail of risks is prompting Eigen to favor cash and highly liquid assets. His strategy, which can invest in or bet against almost anything in the fixed-income universe, has 21% parked in investment-grade corporate debt. He also favors non-agency mortgages.

Junk bonds now make up less than 5% of the fund from as high as 70% three years ago. While Eigen profited last year from shorting five-year German government debt, he’s not willing to repeat the wager today.

“My feeling is that rates can probably get a bit lower here in the U.S. and German rates will probably follow,” he said.

Even predictions of a further rally in U.S. Treasuries aren’t enough to whet his appetite. His portfolio is “about as defensively positioned as it’s ever been” and he’s building a war-chest of cash to deploy when bond markets sell off. And in the meantime, even if he loses out on some returns, he won’t be buying securities with negative yields.

“I won’t engage in that,” he said. “The day I buy a negative-yielding security is when I’m retired. I don’t do that for investors. If people want to lock in losses they can do it all by themselves.”

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Old 10-20-2019, 09:12 AM
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Quote:
Latest memo from Howard Marks: Mysterious
Spoiler:
Most of the time, my memos have their origin in something interesting that’s happening in the world or in a series of events I come across that I think can be interestingly juxtaposed. This one arises from a less usual source: a request.



The other day, my colleague Ian Schapiro, the leader of Oaktree’s Power Opportunities and Infrastructure groups, suggested I write a memo about negative interest rates. My reaction was immediate and unequivocal: “I can’t. I don’t know anything about them.” And then I realized that’s the point. No one does. But Ian thinks I can make a contribution, so I’ll try. I’ve been saving up clippings on this subject, as you’ll see. Ian’s urging set me to work.





* * *





For a good while now, I’ve used the term “mysterious” in connection with inflation (and deflation). What causes rapid inflation? How can it be stopped? Economists offer explanations and prescriptions regarding each occurrence, but they rarely apply the next time.



And that brings us to the subject of negative interest rates. I find them no less mysterious. The fact that we know what they are – as we do with inflation and deflation – doesn’t alter the fact that we don’t know for sure why negative rates are prevalent today, how long they’ll continue in force, what might cause them to turn positive, what their consequences are, or whether they’ll reach the U.S.





No, I’ll Pay You!



Historically – until the European Central Bank took the rate on its credit facility to -0.10% in 2014 – borrowers paid interest to the people from whom they borrowed money. But in the recovery from the Global Financial Crisis, interest rates went negative for the first time in recent history, meaning some lenders paid borrowers for the privilege of lending them money.



I had my first direct brush with negative interest rates in 2014, when I was making an investment in Spain. The closing was due to take place on Monday, and I wired funds on the prior Wednesday so as to be in position to close. The following conversation ensued with my Spanish lawyer:



Carlos: The money has arrived. What should I do with it between now and Monday?



HM: Put it in the bank.



Carlos: You know that means you’ll get less out on Monday than you put in today.



HM: Okay, then don’t put it in the bank.



Carlos: You have to put it in the bank.



HM: So put it in the bank.



That’s it in a nutshell. Money can’t be free-floating in space. It has to be someplace. And you can’t keep much of it in your wallet or under the mattress. Thus, in general, any substantial sum has to go into the bank. And in Europe – then and now – doing so means you’ll get out less than you put in.



I have to admit that this didn’t come as a shock to me. Oaktree and I had turned very cautious in 2005-06, and as a result, all of my money that wasn’t in Oaktree funds was in a “laddered portfolio” of U.S. Treasurys. (In my case, equal amounts of 1, 2, 3, 4, 5 and 6-year maturities. When the closest-in note matures, you roll it to the end of the line. It’s the most mindless form of investing known to man.)



At the time I put that portfolio together, I signed up for a yield in the range of 5-6%. And I was thrilled: the greatest safety, total liquidity and a meaningful yield. But then, in 2007, the Fed started cutting rates to rescue the economy from the sub-prime mortgage crisis. And one day in late 2008, my banker called to say, “The 6% note has matured. You can roll it over at five-eighths.” I asked, “What-and-five-eighths?” “No, that’s it,” he said, “just five-eighths.”



The world had changed. Up until the Global Financial Crisis, we could store money with the government and be well paid to do so. But now my reaction was, “given the level of fear in the financial world, maybe one of these days people will end up paying to store their money safely.”



In the period 2008-14, Europe experienced the Global Financial Crisis, a European debt crisis (with concern over the solvency of “peripheral” nations on Europe’s southern tier), and rapidly escalating prices for commodity raw materials. In response, the European Central Bank and some non-EU countries moved to adopt negative interest rates. Here’s how it goes:



Commercial banks usually earn interest on the extra reserves they keep with central banks, like the Fed or the European Central Bank. Negative policy interest rates force them to pay to keep money in those accounts, a penalty aimed at pushing them to lend more and goose the economy. (The New York Times, September 9)



Central banks determine short-term base rates (“policy rates”) as described above. That establishes the origin of the yield curve, and rates/yields on other types of short-term debt, as well as longer-term instruments, can be expected to respond by moving to a logical relationship with the base rate. Eventually, negative interest rates paid on bank deposits should be reflected in negative yields on bonds. (Note: for the most part, negative rates are applied today only to large deposits. Small depositors have thus far been spared.)



Today, large numbers of bonds – the vast majority being government bonds from Europe and Japan – carry negative yields to maturity. They constitute roughly two-thirds of the bonds in Europe and 25-30% of all the investment grade debt in the world. A few corporate bonds also offer negative yields, however, and there’s even a handful of negative-rate high yield bonds (the ultimate oxymoron).



Further, on September 4 Bloomberg pointed out the prevalence of negative real rates:



While over $17 trillion of the global stock of debt trades at nominal yields below zero, the figure jumps to $35.7 trillion when inflation is taken into account. . . . In the U.S., more than $9 trillion of the nation’s government debt carries yields lower than the CPI rate.



With a negative-rate instrument, the price you pay for a bond today exceeds the sum of the face amount that will be repaid when it matures plus the interest you’ll receive in the interim. That means if you buy a negative-yield bond and hold it to maturity, you’re guaranteed to lose money. Why, then, would anyone want to buy a negative-yield bond? Here are some reasons that make sense:



Fear regarding the future (relating to recession, market declines, credit crisis or further declines in interest rates, among other factors) that causes investors to engage in a flight to safety, in which they elect to lock in a sure but limited loss.
A belief that interest rates will go even more negative, giving holders a profit, as it implies bonds will appreciate in price (as they would with any decline in rates).
An expectation of deflation, causing the purchasing power of the repaid principal to rise.
Speculation that the currency underlying the bond will appreciate by more than the negative interest rate.


The concept behind negative rates is simple. It’s merely the reverse of the traditional norm, in which lenders receive interest from borrowers. Generally speaking, interest rates are a function of two variables: (a) the time value of money and (b) expected changes in the purchasing power of money (i.e., inflationary or deflationary expectations). (Of course, interest rates should also incorporate a risk premium to compensate for any credit risk entailed.) If, for example, lenders want a 2% annual real return to compensate for the time value of money and expect 2% inflation over the next five years, a five-year Treasury note should yield 4%. But if lenders expect deflation at 3% per year, that note should theoretically yield negative 1%.



Are today’s negative rates in Europe and Japan telling us deflation lies ahead? Or have lenders changed their views regarding the time value of money? Or are rates negative simply because governments and central banks want them to be?





Reasons for Negative Rates



Here are some of the reasons I’ve come up with for negative interest rates, some I’ve read about, and some my friends have suggested:



The obvious one: central banks in Europe and Japan want rates to be negative to stimulate their economies. (They want to supply more stimulus than had been afforded by the reduction of rates to near-zero, since that level of stimulus didn’t prove up to the task.)
“. . . central banks around the world are racing to cut interest rates in an effort to stay ahead of the Fed and support their economies by weakening their currencies.” (The Wall Street Journal, August 12)
Ongoing quantitative easing – central banks’ bond purchases – is pushing up the price of longer-dated bonds, and thus pushing their yields down into negative territory.
Quantitative easing means the central banks flood the financial system with money that needs investing. Since borrowers don’t have much demand for long-term capital, they won’t pay to use it. Thus holders have to pay a small fee to store that money.
Fearful investors have little interest in making investments that represent bets on their countries’ economies and companies. They certainly don’t want to borrow for that purpose.
Current economic weakness reinforces investors’ pessimism. Fear of increasing weakness in the future strengthens their desire for safe storage.
There’s so much money in the system that the excess of supply over demand drives down the price of money – borrowing rates – into negative territory. “In today’s global economy, private investment demand is manifestly unable to absorb private savings . . .” (Lawrence Summers, Financial Times, October 12)
Unfavorable demographic trends mean central banks can’t maintain positive rates without curbing growth.
The lack of inflation means investors needn’t demand protection against the loss of purchasing power over time. The wonders of technology may continue to make products available cheap or free, capping inflation.
Fear of deflation adds further to the willingness to invest without such protection.
“The rise of businesses dealing in intangible products has rendered the economy less capital-intensive . . .” said Grant’s Interest Rate Observer on July 26. This reduces the demand for long-term borrowings.
Certain regulations require financial institutions to invest in home-country sovereign bonds regardless of the yield they offer (and whether it’s positive). This artificially lifts the demand for (and thus the prices of) those bonds.


Everyone has favorites from this list. But everyone differs, including the “experts.” Some people think we have negative rates because central bankers want them, some think it’s because the market sets them, and some think it’s some of each. “Did interest rates fall, or were they pushed?” asks Grant’s. Given all the above, no one should feel the reasons for negative rates are fully understood.





The Impact of Negative Rates



A quote attributed to Albert Einstein in various forms is relevant to this discussion.



Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it. (RateCity)



Under compound interest, by not withdrawing interest as it is earned, not only does an investor earn interest on his principal year after year (as with simple interest), but each year he also earns interest on the interest that was earned in the preceding years. Thus principal can grow powerfully if left invested for a long period. (At 10%, $100 grows to $300 in 20 years under simple interest, but to $673 if allowed to compound.) What a wonder!



There’s one problem, however. The miracle of compound interest works in reverse if the interest rate is negative, making Einstein wrong about its virtue. Who would want to reinvest income at negative rates? And where would income come from for that purpose?



It’s not just Einstein’s observation that may be rendered invalid. Negative rates turn a lot of the usual processes upside down. Here are several examples:



Negative rates make life more difficult in a TINA (“there is no alternative”) world. Many investors don’t want to knowingly sign on for negative rates. That makes risky investments preferable, even if they promise historically low prospective returns. In this way, risk aversion is discouraged. “I have no choice but to go into risky assets, because I can’t accept a negative return on safe ones.”


There is clear evidence that this is happening among institutional investors. The flow of pension fund money into any asset that promises to beat zero-rate bonds has been so dramatic that equities, junk bonds, property, private equity and a host of other more abstruse areas of investment have spiraled in value – and to such an extent that they look highly vulnerable to any shock . . .” (Financial Times, August 5)



Proof? What about the fact that in early July, a €3 billion offering of Italian sovereign bonds maturing in 2067(!) was almost six times oversubscribed thanks to its lavish 2.877% yield? What a bonanza Italy was at the time, with a 10-year bond out-yielding Germany’s 10-year by 215 basis points, 1.78% to -0.37%.



There’s no longer any reason to pay slowly in order to make money on “float.”


In the old days, people paid their bills on the last possible day, preferring to keep the money in the bank and earn interest as long as possible. Under negative rates they may prefer to pay sooner.
Many insurers traditionally have made money primarily because they paid claims years after they collected the premiums on the policies they issued. What happens if it costs them money to hold float until claims are paid?


Likewise, there’s no impetus to collect receivables quickly. In the past, wholesale customers were offered discounts for paying bills early. Now the seller might say, “No, you keep it. I’d rather you paid me in six months.”
Negative rates put pressure on people, such as retirees, who live on the income from their investments.
Importantly, the pessimistic signals sent by negative rates may mean they have a contractionary rather than stimulative effect.


Research has suggested that Japan’s negative rate policies may have backfired, actually lowering inflation expectations instead of firming them, as hoped. (The New York Times, September 11)



Last week famously blunt ING boss Ralph Hamers excelled himself, all but calling the ECB idiotic for planning to shift rates further downwards. “The negative rate environment is making consumers so uncertain about their financial environment that they’re starting to save more rather than less,” he said.



Mr. Hamers has a point. Rather than encouraging people to borrow and spend, the data suggests nervous eurozone consumers are hoarding. Eurostat reports the eurozone household savings ratio is at a five-year high of nearly 13 per cent. (Financial Times, August 5)



If interest rates for small savers ever were to go negative, it would give rise to the juxtaposition of income penalties for households with benefits for “the elites” through their ability to profit from rising equity prices. Economic impact aside, the boost to populist politics would likely be dramatic.
Negative rates can distort the workings of floating-rate financial products. Lenders and depositors might have been happy in the past receiving interest rates at a spread over the base rate Euribor. With a negative base rate, however, loans and deposits might leave them with less money than they anticipated as time passes.
Negative rates on U.S. Treasurys would, for example, harm the Social Security Fund (which can only invest in Treasurys), hastening the day when it runs out of money.
Negative rates can warp the calculation of discounted present values. In particular, when the discount rate is negative, the present value of future pension obligations can exceed their future value. The combination of high discounted obligations and low yields on investments can be disastrous for the funded status of pension funds.
Ditto for the impact on bank profitability. Negative rates charged to borrowers can sap the returns banks depend on, throwing countries’ banking systems into reverse. Already, some banks have seen the need to issue mortgages with negative interest rates. “In a negative rate environment, the bank must pay to hold loans and securities. In other words, banks would be punished for providing credit . . .” (Jim Bianco on Bloomberg, September 3) “Certainly Europe’s bankers are squealing, as they feel margins squeezed by low rates on lending and a reluctance to pass on negative rates to depositors.” (Financial Times, August 5) Big banks can charge negative rates to corporate and HNW depositors, but as I mentioned earlier, thus far retail banks haven’t passed them on to small savers. Doing so could cause those savers to leave the banking system, depriving it of a traditional source of deposits.
What about the application of negative interest rates to corporate bonds? How will the markets value businesses that hold cash versus those that are deep in debt? Traditionally, markets have penalized heavily levered companies and rewarded those that are cash-rich. But if having negative-yield debt outstanding becomes a source of income, will levered companies be considered more creditworthy? Conversely, how will the market value businesses that hold a lot of cash and thus have to pay banks to keep it on deposit?
Financial models and algorithms – which essentially are a matter of looking for and profiting from deviations from historic relationships – may not work as well as they did in the past, since history (all of which has been based on positive interest rates) may be out the window.


Nobel prizes have been awarded to economists that developed concepts such as the efficient frontier, the Capital Asset Pricing Model and the Black-Scholes option pricing model. But when a negative value is assumed for the risk-free rate in these types of models, fair value results shoot off toward infinity. With trillions of securities and derivatives dependent on these models, valuation is critical. (Jim Bianco, op. cit.)



The one thing we can’t be sure of is that negative rates increase economic growth (or produce more growth than is generated by low rates). First, this requires “what-if” analysis, which is one of the most difficult kinds: are Europe and Japan growing faster today than they would have if their rates weren’t negative? And second, you surely can’t look at their current growth and pronounce negative rates a huge success. Are negative rates stimulating demand, or are they a matter of “pushing on a string,” powerless to convince pessimistic consumers to spend?



In the financial world, most of our actions are based on the assumption that the future will be a lot like the past. Positive interest rates and the desirability of compounding have been among the most fundamental historical building blocks.



If negative rates become more widespread across the globe, then the financial system needs to be rebuilt on a new set of assumptions. The problem is that we do not yet know what those should be or how they would work. (Jim Bianco, op. cit.)



At minimum, negative rates mean there’s increased uncertainty, and thus we have to proceed with more trepidation. Whatever we knew in the past about how things worked, I think we know less when rates are negative.





Will the U.S. See Negative Interest Rates?



As stated above, the vast majority of today’s negative-yield bonds are in Europe and Japan. One of the biggest questions surrounds whether negative rates will reach the U.S.



This question takes me back to my immediate response to Ian’s suggestion that I write this memo: nobody knows, and certainly not me. When something hasn’t happened in the past, it’s impossible to be sure you know how it’ll end up. Different people will express opinions on this subject with differing degrees of confidence. Yet I remain certain that none of them “know.”



If I had to take a guess – and that’s all it would be – I’d say interest rates won’t go negative in the U.S. in the current cycle. If we go back to the possible reasons for them listed on page four, I think we’ll conclude that the factors at play in the U.S. make negative rates less likely:



Stronger current economic growth
Better growth prospects
Thus no need for emergency measures
Higher inflation expectations (especially given the tightness of the labor supply)
Less pessimism
Better uses for long-term capital


So I don’t think current conditions in the U.S. call for negative rates. But that doesn’t rule them out. When you express an opinion, the real question is whether you’ll bet on it and whether you’ll give odds. I might put up $60 to win $50 from you if negative rates don’t materialize. But that’s not a sign of much confidence on my part.



In particular, I wonder about monetary stimulus. The U.S. fed funds rate is below 2% as I write, thanks to the two recent rate cuts (and there might be another cut on the way soon). Yet most stimulus programs have entailed rate cuts totaling several percent. So there’s every possibility that in the future, the Fed’s response to economic weakness could take rates into negative territory.



And the current slowdown in U.S. manufacturing – plus the uncertainty brought on by the on-again/off-again prospect of an escalating trade war with China – raises the possibility of a recession, and thus the need for stimulus through rate-cutting.



Some argue that strong demand for safe assets and negative demographic trends apply in the U.S. also, and thus U.S. bond yields can fall below zero.



Finally, negative rates abroad strengthen demand for dollars so foreigners can invest at the positive U.S. yields, causing the dollar to appreciate. Thus the Fed may have to lower rates to keep the foreign-currency cost of U.S. exports from rising too much, and thus their competitiveness from declining and our economy from weakening. How long can the Fed maintain rates that are much higher than those in the rest of the world?



Maybe I should reconsider my offer of 6-to-5 in favor of rates staying positive . . .





What, Then, Is There to Do?



I’m convinced that no one should be categorical about how to deal with a mystery like this in such unprecedented and confusing circumstances. But the Financial Times of August 5 advanced one idea that seems perfectly logical:



For SFr1,000 a year, your typical Swiss private bank will give you a cubic metre of vault storage for your valuables. Thanks to Switzerland’s high-value SFr1,000 notes, that should be enough space to salt away close to SFr1 billion in hard cash. The fee is a sight cheaper than the SFr7.5 million charge that a 0.75 per cent negative interest rate would imply.



If you don’t like that idea, there is one more: move out the risk curve to strive for returns above those offered by safe instruments in this low-return (or negative-return) world . . . but do so with caution.



What does moving out the risk curve consist of? Essentially it means pursuing greater rewards while accepting the reduced certainty that by definition accompanies that pursuit. (If greater rewards could be obtained without a corresponding increase in uncertainty, that return increment would represent a free lunch, and most of the time they’re not available.)



In a world like the one described above, perhaps the most reliable solution lies in buying things with durable cash flows. Bonds, loans, stocks, properties and companies with the likelihood of producing steady (or hopefully growing) earnings or distributions that reflect a substantial yield on cost all seem like reasonable responses in times of negative yields. In my view, durability and dependability are highly desirable (rather than hail-Mary attempts at a moonshot). They are the Oaktree way.



While all this might be self-evident, the challenge lies in accurately predicting the durability and growth of cash flows and making sure the price you pay allows for a good return. In today’s market environment, assets with predictability are often priced extraordinarily rich, and investors are unusually willing to extrapolate growth far into the future. At the same time, with the economy and markets operating under rules that are different from those of the past in many ways – some of which are reflected above – accurate predictions are apt to prove harder to make than usual. These are some of the reasons why, while simple in concept, investing is far from easy . . . especially today.



October 17, 2019






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Old 10-21-2019, 08:52 AM
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https://www.wsj.com/articles/negativ...es-11571304600
Quote:
Negative U.S. Interest Rates? Options Traders Say Yes
Wagers via Eurodollar options indicate investors’ belief that ‘negative rates are not just possible but reasonably probable’

Spoiler:
Derivatives traders are betting on something once considered inconceivable: zero or negative interest rates in the U.S.


They are scooping up options that would pay out if interest rates fell below zero. The number of bullish contracts outstanding on Eurodollar futures that pay out if interest rates hit zero or fall below has increased to about 1.2 million, according to CME Group data through September.

That is the highest level since at least 2011 and up from about 132,000 contracts last September.Some of these bets are longer dated, expiring in 2021 or 2022. A contract tied to U.S. rates hitting zero is one of the most popular for Eurodollar options expiring in late 2021, according to data provider QuikStrike.

"People are trading things that imply negative rates are not just possible but reasonably probable," said Josh Younger, head of U.S. interest-rate derivatives strategy at JPMorgan Chase & Co. "The market's willingness to price in negative rates has gone up significantly."

Options give investors the right to buy or sell securities by a certain date. Calls confer the right to buy, while puts give the right to sell. Eurodollar futures are derivatives that let investors bet on the future direction of rates, or to hedge other parts of their portfolios. Contrary to their name, they aren't bets on currencies. Higher prices for Eurodollar futures typically correspond to lower rates.

The Federal Reserve trimmed rates twice in the last quarter and left the door open to do so again as soon as this month. Though many consider the U.S. economy to be on sounder footing than others, some investors are girding for up to two more cuts through the end of the year, CME Group data show.

Additionally, the pile of negatively yielding debt world-wide increased to more than $15 trillion in recent months, while 16 central banks -- from India to New Zealand -- slashed rates in the third quarter. JPMorgan analysts expect almost two dozen more to do so through the rest of the year, they wrote in a Sept. 27 note.

Some of this derivatives activity stemmed from investors fretting about the escalation of trade tensions between the U.S. and China, said Arthur Bass, a managing director at Wedbush Securities. As investors' economic outlooks for the U.S. deteriorated, they started anticipating lower and lower rates in the U.S. "There were definitely a lot of fear trades being done," said Mr. Bass.


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