Sunday, July 10, 2016

Today's links

1--Bank earnings loom large as stocks near record

Second-quarter earnings overall are expected to decline 4.7 percent, according to Thomson Reuters data, the fourth straight quarter of negative earnings, but up slightly from the 5 percent decline in the first quarter....

If bank earnings come in better than expected, the S&P 500 .SPX is likely to push through its record highs set in May 2015 after several failed attempts, as Friday's jobs number helped push the benchmark index to less than one point from its closing record high of 2,130.82.

2--Meanwhile, in Japan, Household Consumption Continues to Fall

the windfall profit from the yen’s 2012-2015 down move seems to have been saved. Firms clearly have not been willing to bid up wages. Nominal wages in May were down year over year.**

And above all, the burden of Japan’s 2014 and 2015 fiscal consolidation has been borne by households, and heavily by lower-income households. It is at least possible that the expected impact on household demand from future consolidation is also having an impact on investment. Why invest today to deliver goods and services in the future when when household demand inside Japan is falling, and could fall more

3--I’m in Awe at How Fast Deutsche Bank is Coming Unglued

4---Bonds gone Nuts; The gloomy scenario the “smart money” is betting on.

US Treasuries set new records on Friday: The 10-year note rose to a new high, with the yield dropping to a new low of 1.366%. The 30-year Treasury bond also hit a new high, with the yield dropping to 2.11%, a record low.

If 2.11% sounds like a miserably low return for tying up your money for three decades of hell and high water, it’s practically bond nirvana for whatever else is out there.
The German government, paragon of fiscal rectitude at the moment, one of the few AAA-rated governments left on earth, is able to charge investors for lending it money: the 10-year yield ended the week at a negative -0.187%; the 30-year yield is still positive at 0.35%, but creeping closer to zero.

In Japan, it’s even worse. Fiscally, Japan is the opposite of Germany. It has a lowly A+ credit rating, a gross national debt that has ballooned to 250% of GDP, by far the worst in the developed world, and mega-deficits year after year. Yet its lost-cause debt sports a 10-year yield of negative -0.288%. Even the 30-year bond is dabbling with zero.

Swiss government bonds are the negative-yield-absurdity trailblazers: the 10-year yield, at -0.60%, is the most negative 10-year yield in the world. Even the 30-year yield is negative.

At the end of May, the total amount of government debt with negative yields had reached $10.4 trillion. By June 27, it had jumped to $11.7 trillion, according to Fitch Ratings. Since then, even more debt has skidded into negative-yield absurdity, now exceeding $12 trillion, and moving inexorably higher.
Financial repression, pure and simple...

Investors are now chasing other government bonds, such as US Treasuries, whose yields haven’t fallen to zero yet, so that they too can ride them into negative yield absurdity and profit from what must be one of the greatest scams in the history of mankind....

Then there’s the notion that interest rates can never rise again. Even small increases would cause over-indebted companies, consumers, and governments (those that can’t print their own money, such as state and local governments) to go bankrupt simultaneously. In this theory, however unproven it may be, rates can only fall deeper into the negative to keep this house of cards from collapsing. And thus, government bond prices can only rise. That’s the gloomy scenario the “smart money” is betting on.

5--Why low interest rates encourage saving, not spending

6--Low rates don't effect business investment

The main findings:
The vast majority of CFOs indicate that their investment plans are quite insensitive to potential decreases in their borrowing costs. Only 8% of firms would increase investment if borrowing costs declined 100 basis points, and an additional 8% would respond to a decrease of 100 to 200 basis points.
Strikingly, 68% did not expect any decline in interest rates would induce more investment.
In addition, we find that firms expect to be somewhat more sensitive to an increase in interest rates. Still, only 16% of firms would reduce investment in response to a 100 basis point increase, and another 15% would respond to an increase of 100 to 200 basis points...

So what does determine business investment?
The Global Business Outlook survey also asks CFOs for the top three company-specific concerns they face.
"The responses a firm chooses to this question might be indicative of characteristics that are likely to influence firm investment plans," write Sharpe and Suarez. "The two most commonly chosen of the standard response choices offered are concern with 'ability to maintain margins' and 'cost of health care,' flagged by about 60% and 40% of sample respondents, respectively."

7--Low Rates, Big Spending?

Many experts believe a decline in interest rates has a large effect on households’ consumption by providing extra spending cash through either a decrease in household borrowing costs — lower interest rates make consumers more likely to refinance existing loans — or an increase in wealth, by lowering their already existing monthly debt payments. However, others are skeptical, noting that difficulty in obtaining credit and already high debt levels might limit the ability of consumers to take advantage of low interest rates. “The idea is that two things will happen with low interest rates: banks will start lending again so people can borrow to buy houses; and homeowners can refinance their mortgages, giving them more disposable income, which boosts the economy,” says Professor Marco Di Maggio. “Unfortunately, these are all just theories. Up to this point, there was no evidence that low interest rates really have these effects...

If you give more money to a highly leveraged household, one possibility is that it’s not going to consume all of it. Instead, borrowers will also start repaying debts, building equity in their homes, or paying off credit cards.”
While decreasing household debt helps individual consumers’ financial pictures, it’s not so great for the economy, which depends on discretionary spending — mixed findings that policymakers can use to weigh the pros and cons when making future decisions to change the interest rate. “In the end, the economy was helped by lower interest rates,” Di Maggio says. “But at the same time, that effect was dampened by the precautionary savings incentives for these households, and more importantly by debt rigidities, as households with fixed-rate mortgages were less likely to take advantage of the lower interest rates.”

8--Low Interest Rates: A Self-Defeating Strategy

Instead of encouraging spending and boosting the economy, low rates can lead people to squirrel more money away to meet their retirement or other goals.

Among those shibboleths was that low interest rates always stimulate the economy. Reduced borrowing costs make it easier for folks to buy houses and companies to invest and expand. Lower yields on savings cut the incentives for consumers to stash their cash in the banks like Scrooge and instead make them more inclined to go out and spend and have a good time. And all that spending should tend to push up prices and, in due time, set up the next cycle of rising rates.
And if interest rates ever hit zero, money would be free, which should mean the economy should be like an open bar—a real party. Then think about what would happen if rates went where they never had gone before—below zero percent and into negative territory. Lenders would be paying borrowers, rather than the other way around....

But the boom that the textbooks predict is nowhere in evidence. That’s not a surprise to Jason Hsu, vice chairman and co-founder of Research Affiliates and also a card-carrying Ph.D. and adjunct professor at UCLA. As a frequent visitor to Japan over more than a decade, he’s had a chance to observe firsthand the effect of near-zero interest rates.
In the complete opposite of what classical economics teaches, low returns actually have induced Japanese consumers to spend less, he says. As the aging population saves more to get to a threshold of assets needed for retirement, firms seeing no spending are loath to spend, invest, or hire. “This is a bad spiral that never was predicted,” Jason explains (appropriately enough, over a sushi lunch).

This had always been assumed to reflect both the demographics and cultural traits of Japan. But that world view will have to be revised, as there’s evidence of the same thing happening in Europe, he adds, with Germans reacting to zero interest rates by saving more. This behavioral dimension helps explain the tepid payoff from the unprecedented “financial repression” that has taken interest rates to zero and below.

The restraints on spending from forcing savers to save more in a low-rate environment has been a theme sounded by a number of critics, including David Einhorn, the head of Greenlight Capital, a hedge fund. At a recent Grant’s Interest Rate Observer conference, he quoted Raghuram Rajan, the head of India’s central bank, who, in a lecture at the Bank for International Settlements in 2013, spoke of the plight of someone nearing retirement and facing losses on savings (from two bear markets this century) and low prospective returns. That “can imply low real interest rates are contractionary—savers put more aside as interest rates fall in order to meet the savings they think they will need when they retire.” Indeed, according to a widely cited estimate by Swiss Re, U.S. savers have foregone some $470 billion in interest earnings since 2008....

Financial repression that has depressed rates to levels that are unprecedented in history is having unpredictable effects, which shouldn’t be entirely unexpected. Even if we didn’t learn about them in school.

9--Negative 0.5% Interest Rate: Why People Are Paying to Save

How is this supposed to help the economy?
Pretty much the same way it always is supposed to help the economy when a central bank cuts rates. Lower rates encourage business investment and consumer spending; increase the value of the stock market and other risky assets; lower the value of a country’s currency, making exporters more competitive; and create expectations of higher future inflation, which can induce people to spend now

But as negative rates — in which depositors pay to hold money in bank accounts — become a more common fixture, there are many unknowns about what these policies mean for finance, for the economy and even for the definition of money....

What are those downsides?
The global financial system is built on an assumption of above-zero interest rates. Going below zero could cause damage to the very architecture by which money and credit zoom through the economy, and in turn inhibit growth.
Banks could cease to be viable businesses, eliminating a key way that money is channeled from savers to productive investments. Money market mutual funds, widely used in the United States, could well cease to exist. Insurance companies and pension funds could face their own major strains.
In a speech last year, HervĂ© Hannoun, then the deputy general manager of the Bank for International Settlements, even argued that this could “over time encourage the use of alternative virtual currencies, undermining the foundations of the financial system as we know it today.”

10--Negative rates: ‘A Sign of Desperation’

“Negative rates are a sign of desperation, a signal
that traditional policy options have proved ineffective and new limits need to be explored,” the Bloomberg analysis said. “They punish banks that hoard cash instead of extending loans to businesses or to weaker lenders. Rates below zero have never been used before in an economy as large as the euro area.”...

Negative rates are intended to produce an incentive to spend rather than save, and spending should help fire the economy and push prices up. ....

If they lower the interest rate enough, then you will start spending” instead of saving, Goldstein explains. “[People] can invest in real estate. They can put it into a stock, put it into a bond. They can start a business…. With most of those things, the hope is that they are going to stimulate the economy.”
That’s a good thing, right? Isn’t the point of a negative rate to get those with cash to put it to work — building new factories, hiring workers, spending on goods and services or investing in companies?
It’s good if the theory holds up, but there’s too little experience to know that it will. According to Christopher Swann, a strategist at UBS Wealth Management, the strategy could backfire if it cuts bank profits by narrowing the difference between the rates banks charge borrowers and the rates banks pay to get cash for loans. “If profits suffer too much, banks may even scale back lending,” he wrote in a February report.
Also, it is not clear negative rates could push investors from bonds to stocks, lifting equity indices. Indeed, the narrowing of bank profitability could actually hurt stocks because banks such as those in the U.S. and Japan comprise a “large proportion of equity market capitalization,” Swann said...

So, will negative rates stimulate economies as intended, or have some perverse unintended consequence?
“It’s hard to say,” Goldstein says. “At the end of the day, monetary policy is limited in what it can achieve.” Central banks have kept interest rates at historical lows for years and growth has remained sluggish anyway. “It’s effective to some degree, but it’s not a magic bullet.”

11--Japan’s Negative-Rate Experiment Is Floundering

Trading withers in money markets, yen goes on a tear; ‘every day is like being Alice in Wonderland’

“Every day is like being Alice in Wonderland,” said Tomohisa Fujiki, head of interest-rate strategy at BNP Paribas Securities Japan. “Interest-rate levels are having little effect on credit demand, the market function is declining. You can’t expect everything to go according to plan.” ...

Traders also have pushed up the yen believing Japan’s central bank can’t do much more to ease policy.
There is no guarantee that lowering interest rates encourages corporate capital expenditures or expedites the shift of household financial assets from savings to investment,” said Nobuyuki Hirano, president of Mitsubishi UFJ Financial​Group​Inc., Japan’s biggest bank, on Thursday, adding the negative-interest policy had caused households and businesses to rein in spending amid growing uncertainty over the future. ...

“If the money market dries up, if there is an event like the Lehman crisis, there won’t be the infrastructure for banks to raise capital,” said Naomi Muguruma, strategist at Mitsubishi UFJ Morgan Stanley Securities. “It could cause interest rates to rise sharply.”...

Problems in the money markets have run counter to Mr. Kuroda’s expectations: last month he said that as market players get used to negative rates, money-market trading should increase. Mr. Kuroda predicted banks that had to pay a minus-0.1% interest rate on some of their reserves would want to lend out that money for a higher rate.
Instead, Japanese financial institutions have been searching overseas for higher returns, without a corresponding rise in investment at home. Japanese investors bought a total of ¥5.47 trillion ($50 billion) worth of foreign securities in March, up 11% from February, according to the finance ministry. ...

“There’s no rhyme or reason on why the yen would strengthen when interest rates are negative,” said Bart Wakabayashi, managing director at State Street Global Markets. STT 2.29 % “But the yen has now reasserted itself as a safe-haven currency on concerns about China and the global economy. And at the same time, doubts are emerging over the staying power of Abenomics

12--Galbraith: Stimulus is a short term fix

13--Six years of low interest rates in search of some growth

NEVER in recent economic history have interest rates been so low for so many for so long....When rates were first cut to their current levels in 2008-2009, it looked like a temporary expedient; now it looks like normality.....History offers plenty of prolonged periods of low interest rates that encouraged speculative booms, particularly in property...

Excessively low rates help to create bubbles because they allow investors to ignore the cost of financing and concentrate on the capital gains if their strategy works; they let people forget risk and focus too much on reward. Encouraging the revival of a property market in the doldrums risks creating a boom that will simply lead to another bust. Bubbles may not have emerged yet. But if they do, the eventual task of returning to normal monetary policy will be made even more complicated....

(Low rates encourage reckless, antigrowth investment)
Low rates have not just made life easier for some consumers and big companies by reducing their borrowing costs. They have also allowed firms to substitute debt for equity. This usually boosts earnings per share, which makes it an attractive choice for executives motivated by share options. American companies spent around $400 billion last year buying back their own shares, the equivalent of 2.6% of GDP. British ones spent 3.1% of GDP the same way. The trend has continued in 2013. By March 7th, $111.6 billion of American share buy-back programmes had been announced, a 96% increase on the same period in the previous year, according to Thomson Reuters.

Easy money also lets you buy other companies. In 2007 America saw $1.6 trillion in mergers and acquisitions, part of a world total of $4.6 trillion, according to Dealogic, a data provider. The world’s 2013 total for takeovers was just $2.7 trillion; in America the market has been bumping along at or below $1 trillion a year..

A further sign of an appetite for financial risk is the willingness of investors to buy loans with minimal protection in the case of a deterioration in the debtor’s financial position—so-called covenant-lite loans...

Another sign that growth may not be wholesome is the revival of the asset-backed security....

It would be better if low rates encouraged companies to put their money to work by building new factories and employing more workers. Companies certainly have the cash. American firms are sitting on around $1.8 trillion, European ones some €1 trillion ($1.5 trillion

In theory, low rates should persuade companies to boost investment. Businesses keep lists of projects they might want to finance based on their expected returns. Whether they proceed with the project will depend on how impressively the expected return exceeds the cost of financing them. The lower the cost of borrowing, the lower the hurdle a project’s rate of return has to surmount. In practice investment, as a proportion of GDP, is lower than it was before the crisis in America, Britain and the euro area (see chart 3)....

This is no surprise to people watching Japan, where nominal interest rates have been near zero for a decade (although real rates are positive) and the absolute level of investment is no higher, in real terms, than it was in 1997. “Corporations have been caught in too many cycles where they invested in anticipation of domestic growth that never happened,” says Richard Katz, who writes the Oriental Economist newsletter. Businesses do not invest because the economy is weak; the economy stays weak because businesses do not invest...

there are some areas where the effect of low rates is unambiguously negative....

Insurance companies face a similar issue. The return they get from investing money taken in as premiums before it is paid out as claims is a crucial part of their income.

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