glass floor skyscraper

Interest Rate Vertigo

“How much lower can bond yields go?” is the 3 trillion euro question these days.  Ed Yardeni says “US bond yields could continue to decline as overseas investors scramble to get better yields than the negative and near-zero ones available in Japan and the Eurozone.  This is especially the case if the dollar continues to strengthen, which it will if foreigners continue to snap up US bonds.”  You see, there’s a lot of negative yield out there these days: “According to JPM, the total universe of government bonds traded with a negative yield was $3.6tr last week or 16 per cent of the JPM Global Government Bond Index.”  K.  So let’s go back to our question, but change it slightly: “How much lower can negative yields go?”  As one Reuters columnist puts it: “The numbers after the minus sign could become larger.”  Indeed.  Here’s something else to consider: “the recent experience in Switzerland shows that even a small amount of reserves subjected to negative interest rates can have a big impact on bond yields.”  For example, banks in Switzerland with “20 times the minimum reserve requirement” are “subjected to the punitive -75bp depo rate…This is enough for these institutions to rush to get rid of these deposits by purchasing bonds with yields as low as -75bp in order to reduce this loss.  Most likely they purchase these bonds from banks not subjected to negative depo rate.  As a result, 7-year Swiss government bond yields declined to as low as -67 bp last week.”  JPMorgan “calculates there is currently €220 billion of bank reserves subject to negative interest rates, which looks set to grow exponentially because of the ECB’s forthcoming colossal bond-buying program.”  Meanwhile, Gavyn Davies says the cost of storing and securing money might be the new lower bound: “If the central banks were to drive the yields on bank deposits too far into the negative zone, banks and eventually their customers would choose to hold cash instead of the negative yielding deposits…But cash is very inconvenient to hold and use for large transactions…The key question is how valuable these benefits of security and convenience are…In the past, economists have always assumed that the convenience yield on bank deposits is extremely small, so there would be a stampede into cash…But no one really knows whether that is true.”  Meanwhile, here’s something ELSE to consider (I know!): “Thanks to the anticipated debt purchases by the ECB and the continuing purchases by the Bank of Japan, net issuance of sovereign debt from advanced economies that’s available to the private sector will turn sharply negative this year and next.”  The supply of risk free assets is shrinking at the same time that central banks are increasing demand.  “The bottom line is that the barriers to negative rates are fast falling, particularly in Europe, and with it estimates of how low rates can go…Does the risk/reward of buying 10-year German bunds at 0.37% change in a world where significant negative nominal rates are possible?  If so, the implications for volatility and skew in rates, and therefore all assets and currencies, are large.”

 

Meanwhile, US Equities Ho-Hum It Along

A closer look at previous 6-year recovery periods and US equity returns suggests that the returns we’ve seen so far in the S&P 500 have been pretty normal by comparison.  Furthermore, “valuations might be higher than usual, but the market is also much healthier than usual…Profit margins of nonfinancial S&P companies — and especially manufacturers — have risen sharply in recent years because of structural changes driven by globalization, outsourcing and process reengineering…Financing expenses account for about 1.5% of US company sales today…What’s more, many companies have locked in low rates on their extended maturities, which should help mute the future impact of rising rates on profit margins.”

 

EU: Germans Favor Keeping Around That Friend That Nobody Really Likes Just A Little Longer

 

USA: Obama Thinks Apple Should Probably Pay For New Bridges And Roads And Stuff (Alt)


FYI:
“1930s” Is Your Cue To Stop Reading

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