James Bianco, president of Bianco Research, warns of unintended Consequences of negative interest rates and is concerned about a credit event triggered by defaults in the energy sector.
It’s getting suspiciously silent at the global financial markets. After a strong rebound the US stock market is losing steam and has been moving sideways for two weeks. Jim Bianco remains alert. The influential market strategist from Chicago who is highly regarded among institutional investors is especially concerned about the eagerness to experiment among central bankers. «The larger issue here is that nobody understands negative rates», says the outspoken president of Bianco Research. He is also skeptical with respect to the recent rally in the oil market. He draws worrisome parallels to the subprime crisis in the US housing market and spots the risk of a credit event if the price of oil tanks again.HT: ZeroHedge
Mr. Bianco, negative interest are causing a lot of stir at the financial markets. It looks like even the Bank of Japan is having some doubts now, since it didn’t launch more monetary stimulus this week. What’s your take on negative interest rates?
Even if you go back to the Egyptian pharaohs and the Fertile Crescent in Mesopotamia we have never consistently seen negative interest rates in the reported human history until two years ago. That’s why investors are worried that negative rates are going to create distortions and what you see out of Japan are some of those distortions. The Bank of Japan is not getting the market reaction that it expected. So if negative yields are not a mistake then central bankers have to do a better job in explaining to the world why this is going to work out just fine.
Why are many investors so skeptical about negative interest rates?
People are still staring at negative interest rates and still not comprehending them. When the ECB introduced negative interest rates two years ago the world viewed it just as a temporary gimmick. But then, on January 29th, the Bank of Japan comes in and they go negative as well. After the Bank of Japan decided to go negative, the number of outstanding bonds with a negative yield suddenly doubled in about two days. If you exclude the US market, around 45% of sovereign bonds in the world are now yielding negative.
Why is it so hard to understand negative interest rates?
The problem with negative rates is two-fold. Firstly, it’s a procedure problem. Even though we at the financial markets look at our screens and see negative numbers, negative interest rates don’t exist at the consumer level. The banks in Europe are not offering negative mortgages, they’re not offering negative deposits and they’re not issuing bonds with negative coupons yet. If a country like Switzerland was to issue a negative coupon sovereign bond that means that every owner of that bond has to pay the issuer. But how do you collect that money? Nobody’s got a system in place that can reach out to bondholders and get all those checks. Or how does a negative mortgage work? With a negative mortgage, instead of you paying the bank, the bank pays you. But how does the bank pay you? They don’t have a system in place to mail out all those checks.
Negative interest rates turn the whole credit process upside down. Let’s say we have a system in place and a company has thousand and thousands of bondholders that own its bond with a negative coupon. What’s the credit rating of that security? It’s not the credit rating of the company. It has to be some kind of total of the people that own this bond and that’s probably a junk rating. So how does the company get the money from everybody? What happens if some bond holders don’t pay? And what are the collection procedures for people that are in arrears? That’s the problem with such kind of securities and that’s why people thought it was just a gimmick.
So what are the consequences of negative interest rates?
In a negative interest rate world currencies yield zero and that’s actually a high yield. As a matter of fact, according to former Fed-chief Ben Bernanke the Federal Reserve did a very interesting study that looked at the volume of all of the vault space at the major banks in the US and they calculated a break-even. They calculated that if the Fed Funds Rate ever got below -35 basis points, the banks would be better off by stacking in the volume of their vault space with $100 bills yielding zero as opposed to taking a Funds Rate at -35. There is no such study for European banks. But Bernanke believes that their break-even would be even closer to zero, something like -20 or -15 basis points because they have a 500 Euro note which is six times the monetary value of a $100 bill and roughly the same size. Yet, we’re seeing no movement out of the European banks to stack 500 Euro notes in their vaults. That means they’re acting irrationally. They’re not acting that way because they don’t believe it or they don’t understand it. So we’re still all trying to feel around in the dark as to what this means. And that means that the chance of an accident is very high.
Also, when you look at the poor performance of European bank stocks, negative interest rates seem to cause severe concerns among investors in the financial sector.
Deutsche Bank’s share price is under its 2009 low. That was the level at which we thought the world was ending. So what does it mean that Deutsche Bank’s share price is lower than that? Does it mean the world is ending for the largest European bank by assets? And by the way, Credit Suisse (CSGN 14.57 -4.08%) is not far behind. Of course, Deutsche Bank’s on the hook for a lot of other things, too. They’ve missed on regulation, they’ve missed on capital, they’re in the wrong line of business and they have significant risk. Deutsche Bank (DBK 16.47 -5.13%) is the largest holder of Euro denominated derivatives. So what happens if it comes to a Brexit or if it comes to a Grexit? The problems in Greece never went away. We’ve just decided that we got bored to talk about it.
And what about the big banks in the United States. The performance of US bank stocks is pretty disappointing as well.
Coming out of the financial crisis, the five largest financial institutions in the United States now have a higher concentration of financial assets. Not only do they have a higher concentration of assets than they did before the financial crisis but it’s the largest concentration ever. So we’ve made the too-big-to-fail-problem worse because we have bigger, more systemically important financial institutions now than we did in 2007 – and nobody seems to know what to do about it....MORE