Saturday , 18 November 2017


Negative Interest Rates Becoming More Prevalent – Here's Why You Should Be Concerned

 

The once unthinkable might become policy: negative nominal interest rates. Investors should care as they may be increasingly punished for not taking risks yet masochistic investors believe they may be the prudent ones given the risks lurking in the markets. What are investors to do, and what are the implications for the U.S. dollar and currencies? Words:

So says Axel Merk (www.merkfunds.com) in edited excerpts from his original article*.

Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) and www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.

Merk goes on to say, in part:

Return on Investment

 

When investors deposit money in a bank, they are giving the bank a loan. Some investors aren’t so sure whether zero or close to zero percent interest compensates them for the risk of lending money to the bank, although FDIC insurance where applicable may alleviate that concern. 

Negative Yields Abound

Nevertheless, there are plenty of deposits that are not FDIC insured, such as money market funds which must invest in risky assets to cover their expenses and pay any yield and, as such, are investing in U.S. dollar denominated commercial paper issued by European banks….This flight to “safety” is taking on pandemic proportions -[and now government bills are being offered at negative interest rates by the following European countries:]

  • Germany: 6-month bills at -0.122%,
  • Switzerland: 6-month bills at -0.1%,
  • France: 3-month bills at -0.005%,
  • Netherlands: 3.5-month Treasury Certificates at -0.041% and 6.5-month Treasury Certificates at -0.029%,
  • Belgium: 3-month bills at -0.016%,
  • the European Financial Stability Facility (EFSF), let’s call it a precursor to Eurobonds, 6-month bills at -0.0113%.

In the U.S., inflation protected securities (TIPS) have sold with negative yields at auction for some time:

  • 5-year TIPS at -0.635%, a negative yield for the first time at a U.S. debt auction as investors bet the Fed may be successful in sparking inflatiion,
  • 10-year TIPS at -0.046%, with investors willing to pay a premium to guard against the threat of rising consumer prices.

What is noteworthy about these is that the negative yields were auction results. In the secondary market, Treasury securities have flirted with negative yields periodically throughout the crisis:

Treasury Yields

 

Negative yields late last year were, in our assessment, directly linked to the flight of U.S. money market funds out of European commercial paper, causing funding strains for such European financial institutions. The world’s policy makers were alarmed as European banks in turn have been the primary players in providing U.S. dollar denominated funding to emerging markets.

Confused? It’s an illustration of the “contagion,” how a crisis in Europe can affect the globe. Always eager to lend a friendly hand, the Federal Reserve opted to open a “swap line,” making cheap U.S. dollars available to central banks around the world, most notably the European Central Bank:

Liquidity Swap

 

The negative yields on U.S. Treasuries dissipated once the Federal Reserve provided the loans to the ECB (there was one dissent at the time at the Fed, arguing that such swap lines are fiscal, not monetary policy and ought to be authorized by Congress).

Where Should One Hold Their Cash?

When “investors” hold the U.S. dollar, do they:

  • hold cash on hand (good luck doing that with larger amounts)?
  • deposits in a bank?
  • in money market funds?
  • in U.S. Treasuries?

Similarly, when “investors” hold the euro, do they place it in

  • a German, Spanis or Greek bank?
  • a Spanish, German or Dutch Treasury bill?

Should the euro break apart, one could buy a longer dated German security in the assumption that such security will be converted to a new Deutsche Mark and appreciate in value versus the current euro.

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We have argued since 2006 that there may not be such a thing anymore as a safe asset and investors may want to take a diversified approach to something as mundane as cash….

This analysis might be most relevant for the countries not mentioned, Japan, [where]…the Bank of Japan scrapped a 0.10 percent yield floor for government bond purchases, opening the door to the possibility of buying debt with negative returns….

Investors not interested in negative yields should:

  • look at other currencies…of countries with higher rates…[that] may be more removed from the crises and thus able to focus on sound monetary policy rather than subsidizing governments, banks or consumers….
  • buy riskier assets, such as equities or
  • invest in property, plant & equipment.

The above are the types of activities central bankers would like to encourage us to do.

[Interestingly, however,] there’s also a good reason to accept the negative yields…In a crisis the winners are those that lose the least and, as such, investors may have good reason to be on the sidelines in the belief that better prices may be available for riskier assets down the road.

[Unfortuneately, central bankers are…[so] afraid of deflation…they may be tempted with even lower rates, [thereby] punishing savers. As such,  get prepared for a negative ( nominal, not real rates after inflation is taken into account) interest rate environment….

*http://www.merkfunds.com/merk-perspective/insights/2012-07-25.html  (To access the above article please copy the URL and paste it into your browser.)

Editor’s Note: The above posts may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.

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Natixis, the French investment bank and asset manager has determined that the safest country – the country whose bonds are really risk-free – is Sweden, the only one to score a perfect 5. Where do the U.S., Canada, the U.K., Australia and other major countries rank. Take a look.

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