Speaking at the New York Society of Security Analysts (NYSSA) Annual Benjamin Graham Conference over the weekend, bond analyst James Grant leveled heavy criticism of the global addiction to sub-zero interest rates.
From The CFA Institute:
Central banks are treading in uncharted waters. Sidney Homer and Richard Sylla, the authors of A History of Interest Rates, found no instance of negative rates in 5,000 years. Now there are $11.7 trillion invested in negative-yield sovereign debt, including $7.9 trillion in Japanese government bonds and over $1 trillion in both French and German sovereign debt.
Grant posed a tongue-in-cheek question: “If these are the first sub-zero interest rates in 5,000 years, is this not the worst economy since 3,000 BC?”
This is not a bad economy by most measures. Household wealth in the United States has grown steadily since the Great Recession. If these gains were the result of greater productivity, interest rates would not need to stay at historic lows. Grant says they are “a sign of someone’s thumb on the currency.” Negative rates are propping up risk assets. He critiqued US Federal Reserve chair Janet Yellen’s touting of the bull market in equities as a sign of prosperity by alluding to Brexit voters.
“Asset prices have failed to pacify the world’s unprofitable voters,” Grant said.
Because of all this pressure that low interest rates have put on global markets, we now have several potential crises looming. Grant noted:
Though savers are yet to hoard cash in their mattresses, negative rates could have other consequences. Negative funds rates squeeze banks’ profit margins. Low enough rates could cause many to become unprofitable. Pension funds depend on bond yields to meet their payment requirements. Grant says it is now impossible for them to hit 7% return targets. Insurance companies invest their premiums in fixed income, and are “dying on the vine” according to Grant.
If interest rates rise due to inflation or pushback from the market, several countries could have difficulty coping with the higher costs of borrowing. Italian stocks tumbled after Brexit, indicating that investors may fear a debt crisis. Japan will have even more difficulty disposing of its debt. Japan has the highest debt-to-GDP ratio in the world at over 200%, in part due to Abenomics intended to prop up stock prices and inflation. Grant also thinks China’s wealth management products are a threat to default.
Grant also said that he’s interested in gold because it’s an investment in monetary disorder. When the negative interest rate bubble pops, investors will probably clamor for hard assets — physical stores of wealth that are largely disconnected from the financial markets.
For now, the bond market is showing no signs of slowing down. But when it does, fireworks will almost certainly ensure.
The iShares Barclays 20+ Yr Treasury Bond ETF (NASDAQ:TLT) fell $0.07 (-0.05%) in premarket trading Monday to $137.93 per share. The TLT has gained 14.5% year-to-date, doubling the return of the S&P 500 in the same period.
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