Tag Archives: ZIRP

The Fed, QE, And Why Rates Are Going To Zero

Summary

  • On Tuesday, Federal Reserve Chairman Jerome Powell, in his opening remarks at a monetary policy conference in Chicago, raised concerns about the rising trade tensions in the U.S.
  • The extremely negative environment that existed, particularly in the asset markets, provided a fertile starting point for monetary interventions.
  • Given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors.
  • This idea was discussed in more depth with members of my private investing community, Real Investment Advice PRO.

(Lance Roberts) On Tuesday, Federal Reserve Chairman Jerome Powell, in his opening remarks at a monetary policy conference in Chicago, raised concerns about the rising trade tensions in the U.S.,

“We do not know how or when these issues will be resolved. As always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.”

However, while there was nothing “new” in that comment, it was his following statement that sent “shorts” scrambling to cover.

“In short, the proximity of interest rates to the ELB has become the preeminent monetary policy challenge of our time, tainting all manner of issues with ELB risk and imbuing many old challenges with greater significance.

“Perhaps it is time to retire the term ‘unconventional’ when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in future ELB spells, which we hope will be rare.”

As Zerohedge noted:

“To translate that statement, not only is the Fed ready to cut rates, but it may take ‘unconventional’ tools during the next recession, i.e., NIRP and even more QE.”

This is a very interesting statement considering that these tools, which were indeed unconventional“emergency” measures at the time, have now become standard operating procedure for the Fed.

Yet, these “policy tools” are still untested.

Clearly, QE worked well in lifting asset prices, but not so much for the economy. In other words, QE was ultimately a massive “wealth transfer” from the middle class to the rich which has created one of the greatest wealth gaps in the history of the U.S., not to mention an asset bubble of historic proportions.

https://static.seekingalpha.com/uploads/2019/3/8/saupload_Household-NetWorth-GDP-030519.png

However, they have yet to operate within the confines of an economic recession or a mean-reverting event in the financial markets. In simpler terms, no one knows for certain whether the bubbles created by monetary policies are infinitely sustainable? Or, what the consequences will be if they aren’t.

The other concern with restarting monetary policy at this stage of the financial cycle is the backdrop is not conducive for “emergency measures” to be effective. As we wrote in “QE, Then, Now, & Why It May Not Work:”

“If the market fell into a recession tomorrow, the Fed would be starting with roughly a $4 Trillion balance sheet with interest rates 2% lower than they were in 2009. In other words, the ability of the Fed to ‘bail out’ the markets today, is much more limited than it was in 2008.

But there is more to the story than just the Fed’s balance sheet and funds rate. The entire backdrop is completely reversed. The table below compares a variety of financial and economic factors from 2009 to present.

https://static.seekingalpha.com/uploads/2019/3/8/saupload_Economy-Then-Vs-Now-030519.png

“The critical point here is that QE and rate reductions have the MOST effect when the economy, markets, and investors have been ‘blown out,’ deviations from the ‘norm’ are negatively extended, confidence is hugely negative.

In other words, there is nowhere to go but up.”

The extremely negative environment that existed, particularly in the asset markets, provided a fertile starting point for monetary interventions. Today, as shown in the table above, the economic and fundamental backdrop could not be more diametrically opposed.

This suggests that the Fed’s ability to stem the decline of the next recession, or offset a financial shock to the economy from falling asset prices, may be much more limited than the Fed, and most investors, currently believe.

While Powell is hinting at QE4, it likely will only be employed when rate reductions aren’t enough. Such was noted in 2016 by David Reifschneider, deputy director of the division of research and statistics for the Federal Reserve Board in Washington, D.C., released a staff working paper entitled “Gauging The Ability Of The FOMC To Respond To Future Recessions.”

The conclusion was simply this:

“Simulations of the FRB/US model of a severe recession suggest that large-scale asset purchases and forward guidance about the future path of the federal funds rate should be able to provide enough additional accommodation to fully compensate for a more limited [ability] to cut short-term interest rates in most, but probably not all, circumstances.”

In effect, Powell has become aware he has become caught in a liquidity trap. Without continued “emergency measures” the markets, and subsequently economic growth, cannot be sustained. This is where David compared three policy approaches to offset the next recession:

  1. Fed funds goes into negative territory, but there is no breakdown in the structure of economic relationships.
  2. Fed funds returns to zero and keeps it there long enough for unemployment to return to baseline.
  3. Fed funds returns to zero and the FOMC augments it with additional $2-4 Trillion of QE and forward guidance.

This is exactly the prescription that Jerome Powell laid out on Tuesday, suggesting the Fed is already factoring in a scenario in which a shock to the economy leads to additional QE of either $2 trillion, or in a worst-case scenario, $4 trillion, effectively doubling the current size of the Fed’s balance sheet.

This is also why 10-year Treasury rates are going to ZERO.

Why Rates Are Going To Zero

I have been discussing over the last couple of years why the death of the bond bull market has been greatly exaggerated. To wit:

“There is an assumption that because interest rates are low, that the bond bull market has come to its inevitable conclusion. The problem with this assumption is three-fold:

  1. All interest rates are relative. With more than $10-Trillion in debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields in U.S. debt attracts flows of capital from countries with negative yields which push rates lower in the U.S. Given the current push by Central Banks globally to suppress interest rates to keep nascent economic growth going, an eventual zero-yield on U.S. debt is not unrealistic.
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls in Washington, and promises of continued largesse in the future, the budget deficit is set to swell back to $1 Trillion or more in the coming years. This will require more government bond issuance to fund future expenditures which will be magnified during the next recessionary spat as tax revenue falls.
  3. Central Banks will continue to be a buyer of bonds to maintain the current status quo, but will become more aggressive buyers during the next recession. The next QE program by the Fed to offset the next economic recession will likely be $2-4 Trillion which will push the 10-year yield towards zero.”

It’s item #3 that is most important.

In “Debt & Deficits: A Slow Motion Train Wreck”, I laid out the data constructs behind the points above.

However, it was in April 2016, when I stated that with more government spending, a budget deficit heading towards $1 Trillion, and real economic growth running well below expectations, the demand for bonds would continue to grow. Even from a purely technical perspective, the trend of interest rates suggested at that time a rate below one percent was likely during the next economic recession.

https://static.seekingalpha.com/uploads/2019/6/7/saupload_10-yr-interest-rates-bollingerbands-060419.png

Outside of other events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. which all drove money out of stocks and into bonds pushing rates lower, recessionary environments are especially prone at suppressing rates further. But, given the inflation of multiple asset bubbles, a credit-driven event that impacts the corporate bond market will drive rates to zero.

Furthermore, given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors. This will be from both a potential capital appreciation perspective (expectations of negative rates in the U.S.) and the perceived safety and liquidity of the U.S. Treasury market.

Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately, the fundamentals, combined with the demand for safety and liquidity, will be the ultimate arbiter.

With the majority of yield curves that we track now inverted, many economic indicators flashing red, and financial markets dependent on “Fed action” rather than strong fundamentals, it is likely the bond market already knows a problem in brewing.

https://static.seekingalpha.com/uploads/2019/6/7/saupload_Inverted-Yield-Curve-060419.png

However, while I am fairly certain the “facts” will play out as they have historically, rest assured that if the “facts” do indeed change, I will gladly change my view.

Currently, there is NO evidence that a change of facts has occurred.

Of course, we aren’t the only ones expecting rates to go to zero. As Bloomberg noted:

“Billionaire Stan Druckenmiller said he could see the Fed funds rate going to zero in the next 18 months if the economy softens and that he recently piled into Treasuries as the U.S. trade war with China escalated.

‘When the Trump tweet went out, I went from 93% invested to net flat, and bought a bunch of Treasuries,’ Druckenmiller said Monday evening, referring to the May 5 tweet from President Donald Trump threatening an increase in tariffs on China. ‘Not because I’m trying to make money, I just don’t want to play in this environment.'”

It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade, and there is rising evidence that growth is beginning to decelerate.

While another $2-4 Trillion in QE might indeed be successful in further inflating the third bubble in asset prices since the turn of the century, there is a finite ability to continue to pull forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle.

There is evidence the cycle peak has been reached.

If I am correct, and the effectiveness of rate reductions and QE are diminished due to the reasons detailed herein, the subsequent destruction to the “wealth effect” will be far larger than currently imagined. There is a limit to just how many bonds the Federal Reserve can buy and a deep recession will likely find the Fed powerless to offset much of the negative effects.

If more “QE” works, great.

But, as investors, with our retirement savings at risk, what if it doesn’t?

Source: by Lance Roberts | Seeking Alpha

Exploring The Death Spiral Of Financialization [video]

Each new policy destroys another level of prudent fiscal/financial discipline.

The primary driver of our economy–financialization–is in a death spiral. Financialization substitutes expansion of interest, leverage and speculation for real-world expansion of goods, services and wages.

Financial “wealth” created by leveraging more debt on a base of real-world collateral that doesn’t actually produce more goods and services flows to the top of the wealth-power pyramid, driving the soaring wealth-income inequality we see everywhere in the global economy.

As this phantom wealth pours into assets such as stocks, bonds and real estate, it has pushed the value of these assets into the stratosphere, out of reach of the bottom 95% whose incomes have stagnated for the past 16 years.

The core problem with financialization is that it requires ever more extreme policies to keep it going. These policies are mutually reinforcing, meaning that the total impact becomes geometric rather than linear. Put another way, the fragility and instability generated by each new policy extreme reinforces the negative consequences of previous policies.

These extremes don’t just pile up like bricks–they fuel a parabolic rise in systemic leverage, debt, speculation, fragility, distortion and instability.

This accretive, mutually reinforcing, geometric rise in systemic fragility that is the unavoidable output of financialization is poorly understood, not just by laypeople but by the financial punditry and professional economists.

Gordon Long and I cover the policy extremes which have locked our financial system into a death spiral in a new 50-minute presentation, The Road to Financialization. Each “fix” that boosts leverage and debt fuels a speculative boom that then fizzles when the distortions introduced by financialization destabilize the real economy’s credit-business cycle.

Each new policy destroys another level of prudent fiscal/financial discipline.

The discipline of sound money? Gone.

The discipline of limited leverage? Gone.

The discipline of prudent lending? Gone.

The discipline of mark-to-market discovery of the price of collateral? Gone.

The discipline of separating investment and commercial banking, i.e. Glass-Steagall? Gone.

The discipline of open-market interest rates? Gone.

The discipline of losses being absorbed by those who generated the loans? Gone.

And so on: every structural source of discipline has been eradicated, weakened or hollowed out. Financialization has consumed the nation’s seed corn, and the harvest of instability is ripening in the fields of finance and the real economy alike.

Source: ZeroHedge

NIRP Refugees Are Coming to America

Negative interest rate policies elsewhere hit US Treasury yields

The side effects of Negative Interest Rate Policies in Europe and Japan — what we’ve come to call the NIRP absurdity — are becoming numerous and legendary, and they’re fanning out across the globe, far beyond the NIRP countries.

No one knows what the consequences will be down the line. No one has ever gone through this before. It’s all a huge experiment in market manipulation. We have seen crazy experiments before, like creating a credit bubble and a housing bubble in order to stimulate the economy following the 2001 recession in the US, which culminated with spectacular fireworks.

Not too long ago, economists believed that nominal negative interest rates couldn’t actually exist beyond very brief periods. They figured that you’d have to increase inflation and keep interest rates low but positive to get negative “real” interest rates, which might have a similar effect, that of “financial repression”: perverting the behavior of creditors and borrowers alike, and triggering a massive wealth transfer.

But the NIRP absurdity has proven to be possible. It can exist. It does exist. That fact is so confidence-inspiring to central banks that more and more have inflicted it on their bailiwick. The Bank of Japan was the latest, and the one with the most debt to push into the negative yield absurdity — and therefore the most consequential.

But markets are globalized, money flows in all directions. The hot money, often borrowed money, washes ashore tsunami like, but then it can recede and dry up, leaving behind the debris. These money flows trigger chain reactions in markets around the globe.

NIRP is causing fixed income investors, and possibly even equity investors, to flee that bailiwick. They sell their bonds to the QE-obsessed central banks, which play the role of the incessant dumb bid in order to whip up bond prices and drive down yields, their stated policy. Investors take their money and run.

And then they invest it elsewhere — wherever yields are not negative, particularly in US Treasuries. This no-questions-asked demand from investors overseas has done a job on Treasury yields. That’s why the 10-year yield in the US has plunged even though the Fed got serious about flip-flopping on rate increases and then actually raised its policy rate, with threats of more to come.

So here are some of the numbers and dynamics — among the many consequences of the NIRP absurdity — by Christine Hughes, Chief Investment Strategist at OtterWood Capital:

Negative interest rate policies implemented by central banks in Europe and Japan have driven yields on many sovereign debt issues into negative territory.

If you look at the BAML Sovereign Bond index, just 6% of the bonds had negative yields at the beginning of 2015. Since then the share of negative yielding bonds has increased to almost 30% of the index, see below.

With negative yielding bonds becoming the norm, investors are instead reaching for the remaining assets with positive yields (i.e. US Treasuries). Private Japanese investors have purchased nearly $70 billion in foreign bonds this year with the sharpest increase coming after the BoJ adopted negative rates. Additionally, inflows into US Treasuries from European funds have increased since 2014:

“According to an analysis by Bank of America Merrill Lynch, for every $100 currently managed in global sovereign benchmarks, avoiding negative yields would result in roughly $20 being pushed into overweight US Treasuries assets,” wrote Christine Hughes of OtterWood Capital.

That’s a lot of money in markets where movements are measured in trillions of dollars. As long as NIRP rules in the Eurozone and Japan, US Treasury yields will become even more appealing every time they halfheartedly try to inch up just one tiny bit.

So China, Russia, and Saudi Arabia might be dumping their holdings of US Treasuries, for reasons of their own, but that won’t matter, and folks that expected this to turn into a disaster for the US will need some more patience: these Treasuries will be instantly mopped up by ever more desperate NIRP refugees.

by Wolf Richter | Wolf Street

Anything Higher Than 0% Is Now High Yield; Retirees Thrown Under The Bus This Week

From the Seeking Alpha News Team, Oct. 6, 2015:

“Officially joining the 0% bond club, the U.S. Treasury sold a new government security on Monday containing a three-month maturity and a yield of zero for the first time on record. In essence, buyers gave a free short-term loan to the government in exchange for a highly liquid debt instrument for their portfolio. The result adds to the diminishing expectations – stoked by Friday’s disappointing jobs report – that the Fed will keep interest rates at basement levels throughout 2015.”

Record times. Should we break out the bubbly and celebrate, or get out the Valium? Now, after a lifetime of 40-hour weeks, you too can lend your hard-earned money to Uncle Sam and get a negative 2% return for your trouble. (Let’s not forget about that big elephant in the room called inflation.) Figure it into your return calculations and you lose 2% annualized on this “investment”.

The U.S. Treasury has finally joined a rarefied club, along with Germany, Japan and others.

If you are the patriotic type and feel like giving Uncle Sam an interest free loan, be my guest. Do you also pay more tax than required because you think Uncle Sam could use a break dealing with those big deficits? Do you have so much money with no place to go that you’d rather see it locked up, safe and sound for 3 months in Uncle Sam’s vaults than chance it being stolen from underneath your mattress?

Be my guest. I have better ideas for those dollars.

Here’s how the Wall Street Journal reported this astounding event.

By MIN ZENG

Updated Oct. 5, 2015 7:51 p.m.

The U.S. Treasury sold a new government security with a three-month maturity and a yield of zero for the first time on record, reflecting the highest demand since June.

In essence, buyers gave a free short-term loan to the U.S. government in exchange for a highly liquid debt instrument for their portfolio.

The result reflects diminishing expectations in financial markets that the Federal Reserve would raise short-term rates before year-end after Friday’s disappointing jobs report. Yields on these short-term Treasury-debt instruments are highly sensitive to changes in the Fed’s interest-rate policy outlook.

The move occurred on a day that stocks surged, with the Dow Jones Industrial Average adding 304.06 points, or 1.8%, to 16776.43.

The prospect of continued ultra loose monetary support bolstered demand on Monday for riskier assets, including stocks and commodities. That in turn diluted the appeal of relatively safer assets, boosting the yield on the benchmark 10-year Treasury note to 2.058% Monday, from a five-month low of 1.989% Friday. Bond yields rise as prices fall.

The Fed is off the table for 2015 no matter what they say,” said Andrew Brenner, head of international fixed income for broker dealer National Alliance Capital Markets. Investors “will claw their way back” in riskier assets between now and year-end, he said.

Monday’s $21 billion auction of three-month Treasury bills drew $4.14 in bids for each dollar offered, and the resulting bid-to-cover ratio was the highest since June 22. Bills are Treasury debt maturing in a year or less. The Treasury sells bills maturing in one month, three months and six months on a weekly basis.

In terms of demand, concern about Fed hikes in 2015 is evaporating, particularly following the disappointing jobs numbers,” said Andrew Hollenhorst, U.S. short-term interest-rate strategist at Citigroup Global Markets Inc. in New York.

Competition to obtain bills has been intensifying lately. Of the past six one-month bill auctions, five sales were offered at a zero yield.

In the secondary market, some bills have been yielding slightly below zero or around zero for weeks. On Monday, the yield on the one-month bill traded at negative-0.02% and the three-month yield was zero. An investor who holds the one-month bill through maturity will log a moderate capital loss, but that is the price the buyer has been willing to pay to obtain the bills.

It is a bizarre outcome, but that is the world we are living in right now,” said Thomas Simons, money-market economist in the Fixed Income Group at Jefferies LLC. “For many investors investing in short-term markets, bills are the only game in town.”

Bizarre outcome, indeed

Last week, I wrote an article about a bank offering a “high yield” of 1.05% to depositors. I disparaged the misnomer, calling such a product high yield, when clearly, even in ZIRP world, alternatives exist.

Little did I imagine that we’d now be referring to last week’s 3-month Treasury yield of .08% as high yield in comparison to today’s offering of 0%. What have we come to, where anything higher than 0% is now considered high yield?

If there was any doubt in anyone’s mind that we’re stuck at low rates for longer, I think this latest pricing has cleared things up. Which brings us to yet another crossroads:

A. Recognize that this is yet another gift and a tip of the hat to equity markets because cheap money is here to stay, a while longer at least, allowing the equities markets greater running room to extend the six-day rally and re-inflate investors’ wallets. Champagne? Yes, please.

B. Remain downtrodden because we have no place to store our hard-earned money safely and earn any return whatsoever. A little Valium to calm the nerves? Retirees used to being able to comfortably park their money in safe investments like Treasuries and CDs continue to feel the brunt of this zero interest rate policy and perceive that after being thrown under the bus for almost nine years of low rates, now at 0% it feels like that bus keeps crushing them over and over.

I choose alternative A. To accept this proposition from the Treasury is a most certain guarantee that when we are repaid in three months time, we will have lost 2% purchasing power on an annual basis. That strikes me as pure madness.

by George Schneider. Read more in Seeking Alpha

I gotta fever and the only prescription is MORE COWBELL!

Energy Companies Face “Come-To-Jesus” Point As Bankruptcies Loom

Last week, amid a renewed bout of crude carnage, Morgan Stanley made a rather disconcerting call on oil. 

“On current trajectory, this downturn could become worse than 1986: An additional +1.5 mb/d [of OPEC supply] is roughly one year of oil demand growth. If sustained, this could delay the rebalancing of oil markets by a year as well. The forward curve has started to price this in: as the chart shows, the forward curve currently points towards a recovery in prices that is far worse than in 1986. This means the industrial downturn could also be worse. In that case, there would be little in analysable history that could be a guide to this cycle,” the bank wrote, presaging even tougher times ahead for the O&G space.

If Morgan Stanley is correct, we’re likely to see tremendous pressure on the sector’s highly indebted names, many of whom have been kept afloat thus far by easy access to capital markets courtesy of ZIRP.

With a rate hike cycle on the horizon, with hedges set to roll off, and with investors less willing to throw good money after bad on secondaries and new HY issuance, banks are likely to rein in credit lines in October when the next assessment is due. At that point, it will be game over in the absence of a sharp recovery in crude prices. 

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Against this challenging backdrop, we bring you the following commentary from Emanuel Grillo, partner at Baker Botts’s bankruptcy and restructuring practice who spoke to Bloomberg Brief last week.  

*  *  *

Via Bloomberg Brief

How does the second half of this year look when it comes to energy bankruptcies?

A: People are coming to realize that the market is not likely to improve. At the end of September, companies will know about their bank loan redeterminations and you’ll see a bunch of restructurings. And, as the last of the hedges start to burn off and you can’t buy them for $80 a barrel any longer, then you’re in a tough place.

The bottom line is that if oil prices don’t increase, it could very well be that the next six months to nine months will be worse than the last six months. Some had an ability to borrow, and you saw other people go out and restructure. But the options are going to become fewer and smaller the longer you wait.

Are there good deals on the horizon for distressed investors?

A: The markets are awash in capital, but you still have a disconnect between buyers and sellers. Sellers, the guys who operate these companies, are hoping they can hang on. Buyers want to pay bargain-basement prices. There’s not enough pressure on the sellers yet. But I think that’s coming. 

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Banks will be redetermining their borrowing bases again in October. Will they be as lenient this time around as they were in April?

A: I don’t know if you’ll get the same slack in October as in April, absent a turnaround in the market price for oil. It’s going to be that ‘come-to-Jesus’ point in time where it’s about how much longer can they let it play. If the banks get too aggressive, they’re going to hurt the value for themselves and their ability to exit. So they’re playing a balancing act.

They know what pressure they’re facing from a regulatory perspective. At the same time, if they push too far in that direction, toward complying with the regulatory side and getting out, then they’re going to hurt themselves in terms of what their own recovery is going to be. All of the banks have these loans under very close scrutiny right now. They’d all get out tomorrow if they could. That’s the sense they’re giving off to the marketplace, because the numbers are just not supporting what they need to have from a regulatory perspective.

Source: Zero Hedge