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.
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