The Consequences of Negative Rates: Part II

Published on: August 21st, 2019

As Central Banks wrestle with stubborn problems that monetary policy alone cannot solve, Plan A remains trying more of the same failed approach. The prospect of more negative rates around the world and the Fed joining the party is filled with potentially dangerous unintended consequences.

Comments

  • KA
    Kelly A.
    2 September 2019 @ 17:27
    Julian, I just reread for 3rd time. Still loving it, and also your responses to readers. Thank you so much!
  • HK
    Hendrik K.
    1 September 2019 @ 15:51
    Thanks for the Research not and Trade recommendation - one questions: if you only start now from here with Trades what would you recommend today (rather sell/reduce position, if you don't have any)? Thanks
  • RM
    R M.
    21 August 2019 @ 14:12
    Julian: This is an excellent piece of analysis. As a retired boomer seeking real returns to live off of, it also jives with the psychology of reasonably well off boomers. Money will flow to physical assets, including real estate. If and when the $ does break, there will be a flood of paper money to EEM seeking returns. The big question in my mind is timing. Do we get a flush first via $ spike or softer than expected growth, trade war continuation? Or will the money start piling in these sectors without much further downside? Also I think letting some long duration treasuries ride with a stop is still a reasonable bet on rates reaching near zero.
    • JK
      James K.
      22 August 2019 @ 04:41
      From one who works in real estate and owns real estate...in SF area ....the demographics are a problem ....imo Btw anyone know when was the sell some gdx posted ..? Thx
    • RM
      R M.
      22 August 2019 @ 15:25
      Good point on demographics and real estate, prefer to be at the lower price points, I live in Austin, you can (still) buy a house for what a garage costs in SF or NYC. Re GDX, I believe Julian's original target was 30, said to take a piece off and let the rest ride with a higher stop.....25.50.
    • JB
      Julian B. | Contributor
      30 August 2019 @ 23:04
      Hi RM..long run, zero is a given as real rates have trended lower for 500 years! But my hope is that the Fed manages to avoid it this time around by weakening the $, which is very inflationary., good for precious metals, EM etc. With MI2 clients we have suggested selling long dated treasuries here because they are massively overbought. But this trade war threat is real so that's an aggressive trade for pros only. If you want to play a race to zero (not my base case but a risk) take a look at the piece Flash Update we sent on the banks.
  • MC
    Mathieu C.
    21 August 2019 @ 22:48
    Thanks for the paper, it is quite good to read some analysis and thoughts without price actions. Despite economics theory it appeals to me in watching SNB that negative rate attracts speculative capital which are pushing domestic currencies up, probably due to the fact the bond market is liquid and large amount are being involved. This is particularly unwanted as those with negative rates are the weakest one and are begging for devaluating their currencies. Central banks are selling their currency to maintain levels. Correlations are high and volatility low on the whole FX market as everything is being locked up. I don’t think the FX market is that much of a show, if not a huge risks for the dollar if central banks are being pushed close to the point of capitulation. Bonds speculators are working hard, speculating rutheless on the undiscovered and unbounded territory of negative rates. (No offence Raoul! ). Monetary policy has become somewhat disconnected and incapable to contain that flow. Everybody is talking about inverting curve and recession, but isn’t it just speculation following each of Trump’s tweets. The problem is, this isn’t some kind of crazy tech stocks that are largely overvalued that Mr John bought on his way to becoming rich quickly. This is the pension of countless number of people who worked numerous years and for the most of them have no knowledge of financial markets; this is quite a serious ethic topic isn’t it. Who knows when this madness is going to end but buying 30Y bund @ -0.5% (-15% immediate loss) with 2% inflation (-60% cost) will never make sense and the current buyer has certainly no plan to keep that paper long enough in his book. So the question is who is going to be left with it ; someone will certainly have too.
    • JB
      Julian B. | Contributor
      30 August 2019 @ 22:58
      Mathieu I agree the retribution that will come when realise their pensions are insolvent (god help us in European bonds ever sell-off because the loses will be MIND BLOWING). However, I'm not sure that I agree the CHF is attracting speculative capital. I think it is strong in part because its perceived as less of a risk that the Euro (not sure I agree). Also it tends to strengthen in risk off periods because like EURO and the Yen it is used to fund risk. ..
  • MG
    Miguel G.
    23 August 2019 @ 11:13
    BRAVO Julian I read this piece 3 times and printed it out to note take in my journal. Your experience in big picture macro is in full display in this piece of work and I absolutely loved it as it has my wheels turning. You're points are heard loud and clear as you back it up with empirical data. IMO your article not only debunks the usefulness of negative rates, but it also creates an extremely strong argument of why fiscal spending isn't a matter of if but when it will be implemented as monetary policy has reached its limits.
    • JB
      Julian B. | Contributor
      30 August 2019 @ 22:53
      Many thanks
  • MG
    Miguel G.
    23 August 2019 @ 11:54
    One question Julian, a few months back you made the case that if our fed cut rates asap and relaunched QE that they could save this cycle from turning and stretch it out further. Is there a case to be made here in the US as to a possible sell the news event on more monetary policy since we have hard data that supports monetary policy reaching its limits in the EU and Japan? I understand we aren't in negative territory but were also not that far from it either and wondering what benefits if any are left before we reach negative bound if we do at all. Maybe the real pivot to go bullish equities will be once fiscal policy is launched as that should accelerate economic growth.
    • JB
      Julian B. | Contributor
      30 August 2019 @ 22:53
      Miguel another excellent point and its a risk. However, I don't believe we are there yet in the US. One of the main reasons is structural. In Europe and to some extent in Japan pension funds, insurance cos are legally mandated to match asset with liabilities i.e. they were forced to direct QE towards bonds on a relative basis not stocks. In the US there is no such restriction. Hence in Europe QE = lower bond yields. Yes stocks bounce to some extent but far less than in the US and overall performance is undermined by the collapse of the banks, which hate the lower yields and are a big part of European indexes. Add in that Europeans don't own as many stocks as Americans and the whole effect is far less reflationary. Finally, yes the answer is fiscal and we people are slowly to that conclusion …..I just hope we can get to through the election before we hit negative rates.
  • MG
    Miguel G.
    23 August 2019 @ 12:01
    To the point I’m trying to make the consensus thought process from here more QE = higher stock prices as has been the case since 2009. Question becomes after reading your article is has this become a dangerous assumption to make from where rates are today?
    • JB
      Julian B. | Contributor
      30 August 2019 @ 22:33
      Hi Miguel. Sorry I'm not 100% sure what you asking but let me take a stab anyway. I agree that QE = higher stocks, higher bond yields (if it works it reflationary) and if we are lucky a weaker $. To my mind if the Fed is faced with the choice of negative rates and or more QE, they should expand the balance sheet any day of the week. Unfortunately, QE as an option has lost internal support, because they are concerned that it has added to social inequality by making the rich richer (NO S***). Hence my fear that their first choice with be further rate cuts raising the risk of negative yields.