Can you Imagine Negative Interest Rates?
Thanks to its widespread adoption by the central banks of Europe and Japan, roughly 25% of all outstanding government debt now trades with a negative yield.
This includes half of all European sovereign debt… 85% of Germany’s debt… and as of last week, all of Switzerland’s outstanding debt. That’s right, the entire Swiss government bond market – ranging from maturities of one month all the way out to 50 years – now trades with a negative yield.
Worse, we’re now seeing yields on some European high-yield corporate (or “junk”) bonds begin to dip into negative territory. This is complete and utter madness.
The Federal Reserve has already been discussing the use of negative interest rates. And you can bet that if NIRP (negative interest rate policy) continues to spread, banks will eventually start charging “mom and pop,” too.
Bond expert Mark Grant says the real question is the huge and expanding pool of negative-yielding debt in the EU, Switzerland and Japan. Bonds yielding less than zero now make up more than a quarter of the entire investment-grade market. “Different this time” doesn’t begin to explain it.
- Governments in the EU, Switzerland and Japan are basically insolvent, unable to cover their budgets by taxation or normal borrowing. They hang on only due to “manufactured money” from their central banks.
- They are doing this because they can’t afford anything else. They have no other rational choices.
- This is pushing the US dollar up against the Euro, Yen and Swiss Franc, and US yields down.
- The US 10-year Treasury has broken out of its range and is now on a path to 1.70%, Grant estimates.
- Initially, lower rates will be a net positive for equity and other asset prices.
- Yet when lower rates no longer move the needle, we will see market turmoil as various bubbles inflate and then burst.
- The Federal Reserve has no choice but to keep reducing rates so the US can remain competitive with the rest of the world.
Grant says ultra-low and possibly negative rates will wreak havoc on pension funds, insurers, and anyone who depends on savings to maintain their lifestyles, like retirees. Anything that provides any sort of decent cash flow will be bought up, forcing everyone to make much riskier bets that will eventually lead to blow ups. He believes “preservation of capital” is the best rule.
Rates are going lower…..fast! The 10-year Treasury yield dipped below 1.7% for the first time since 2016. With lower interest rates now in the pipeline, this handy chart from our friends at Charles Schwab sketches a map of what lower rates might mean to Americans. The Federal Reserve lowers interest rates by cutting the federal funds rate, which in turn impacts consumer interest rates, bonds, and stocks.
Jeffrey Gundlach predicts that gold’s price will only continue to soar along with the surge in negative-yielding bonds.
“At this point, I think the way to think about it is, as long as the volume of negative interest rate bonds outstanding increases, it’s quite likely that gold moves higher in a similar vein,” the chief executive of DoubleLine Capital told Yahoo Finance.
Gundlach, who oversees more than $130 billion in assets under management, also blames global central banks for what he calls “increasingly negative interest rate manipulation.”
“We are now, I think it’s today or yesterday over $15 trillion of global debt is at a negative yield. And the U.S. bond market is being dragged to lower yields by a combination of the race to ever more negative yields in parts of the developed world, and by weak economic data,” Gundlach said.
Inverted Yield Curve
The Treasury yield curve has been one of the most reliable “early warning” signals for stocks and the economy for decades.
In short, whenever the yield curve has “inverted” – whenever short-term interest rates have exceeded long-term rates – bear markets and recessions have inevitably followed anywhere from six to 24 months later.
Back in March, we noted that more than 50% of the yield curve had become inverted. However, as a result of these recent moves, nearly three-fourths of the yield curve is inverted today…
The US Economy
Even in today’s economy, a growing business should have growing profits. That’s ultimately what makes share prices rise. Gavekal’s Will Denyer writes about some recently-revised government data that says corporate profit growth has gone flat in the last two years. Even adjusting for the 2017 tax cut, profits were far less than we thought. Exactly how to reconcile this data with a bull market in equities is a critical question.
- Last month’s GDP release revised the “national accounts” data for the last three years, and revised non-financial corporate profit growth almost down to zero.
- Previously, pretax profits bottomed in 4Q2016 before rebounding strongly. After the revision the growth is essentially flat.
- After-tax profits still show some growth, but far less than we thought.
- Profits disappeared mainly due to downward revisions in sales and upward revision in labor compensation.
- This helps explain the puzzling combination of weak business investment and strong personal consumption. Workers have more spending power while businesses are reluctant to add new capacity.
The BEA data covers both public and private companies, so it’s not directly comparable to the stock market. Nonetheless, it is consistent with this year’s downtrend in S&P 500 per-share earnings estimates. Stock prices have kept rising as investors willingly pay higher multiples. How long they will keep doing so is a trillion-dollar question.
Below is Goldman’s Bull/Bear Market Indicator. Are we near the end of the bull market?
Copper tends to be a reliable leading indicator of the global economy due to its use in a broad range of industries.
Crude oil is a critical economic commodity as well. And as you can see in the next chart, it appears to be rolling over again, too..
Economists see a higher probability of a US recession within a year.
- Barely a week after indexes like the S&P 500 were sitting at all-time highs, more than 9% of issues traded on the NYSE fell to their lowest prices in at least a year.
- According to Lipper, investors yanked more than $25 billion from equity funds this week, the 2nd-most in 17 years.
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