Posted on 07/13/2016 5:56:18 AM PDT by expat_panama
Capital markets are information engines. When functioning properly, they reflect what investors know – or think they know – about the future. Future expectations are for all to see, discounted in today’s financial prices. Obviously, this doesn’t mean that capital markets are always “right,” for the future comes as it will, caring not a whit whether it was the one we ordered up or not.
For the first time in recorded history, financial interest rates have gone negative. To say this makes no sense is almost tautological. Nobody pays to have their Amazon delivery delayed or their Uber pickup deferred. Consumption now is always prioritized over consumption later, which is why interest rates have been positive for centuries. Is there some set of future expectations that could possibly justify negative yielding debt?
As of 7/11/16; Source: Bloomberg
Were an investor to accept that negative yields actually reflect future expectations, then the sovereign debt market must be calling for a ‘30s style price deflation! Go long canned green peas and head for the hills! 
The Occam’s razor answer is this: the ECB, the BOJ, and yes the Fed too have blocked the capital markets from expressing their “unbiased” future expectations. Rather than let the capital markets reveal investor expectations, the central banks have imposed a pricing regime that reflects what the academics believe to be “better” outcomes.
This is scary. If negative rates are merely the latest in a long line of artifices the central banks have resorted to so as to make the risk carry trade profitable, then look out below! For once the central banks let go of the till (or have it pulled from their hands), this whole financially engineered dynamic goes careening into reverse.
Without active suppression by the central banks, the bond market will call off-sides on negative yields, and sovereign rates will surely “normalize” back to positive rates. But higher government rates will also force cap rates higher everywhere: in stocks, in real-estate, and in the real world where businesses calculate a demanded return in exchange for a capital allocation.
Monetary central planning has not led to the uncorking of the champagne bottles. Instead, it has engineered a condition of overvalued asset prices now propped up by the absurdity of negative rates.
The Fed, et al. are riding the tiger of a great global carry trade. Some have called this the “new normal.” But it is anything but normal and it is also inherently unstable. How unstable?
While no one can say for certain, two metrics that have had a dispositive record of forecasting recession are (1) declining corporate profits and (2) progressively flatter yield curves. We have both:
The Gap in GAAP Earnings
Source: Bloomberg, TCW
* Basic EPS before Extraordinary Items excludes the effects of discontinued operations, accounting standard changes, and natural disasters. Includes the effects of other one-time gains/losses. Uses weighted average shares excluding the effects of convertibles.
Flattening Treasury Curves Precede Recessions
Source: Bloomberg
There is really no mystery as to why these metrics matter. Lower profits force managements to defend their margins by curtailing business investment and by throttling back on hiring. The widening chasm between the “adjusted” earnings that companies report versus what their GAAP calculated earnings would be is yet another red flag. And, of course, flatter yield curves compress net interest margins making leverage less profitable. Less leverage means balance sheets shrink which forces a rationing of credit and a tightening of lending standards. The writing is on the wall.
Our central bankers took the till away from the markets years ago, confident that their policies would chart a course to El Dorado. Instead, they have sailed us off the map, into places that financial markets have never been, and should never be.
Its all done in support of the status quo and the massive, progressive, leftist nanny-state.
The battle lines, in my view, are clear.
If you are conservative and for limited government - you either support a return to free-market currencies and the elimination of the Federal Reserve, or you prepare your mind to be completely dominated by statists, the left, and their various social-engineering programs.
Good article.
If the fed reverses course and begins a realistic pricing of interest rates, the federal budget would have such a high interest burden the entire economy would collapse IMO. When the government decided to make the fed responsible for our economic stability some time ago, they signed our death warrant.
Happy Mid-week and IBD's headline is Market Uptrend Gains Traction; New Milestones For S&P 500, Dow & NASDAQ. Volume rose, indexes gave us another %, while precious metals consolidated. Futures right now have stock indexes +0.82% and metals +0.09%.
--and this week's econ stat flood is beginning:
7:00 AM MBA Mortgage Index
8:30 AM Export Prices ex-ag.
8:30 AM Import Prices ex-oil
10:30 AM Crude Inventories
2:00 PM Fed's Beige Book
2:00 PM Treasury Budget
Also:
Working Classes v Smirking Classes - Daniel Hannan, Washington Examiner
Competition in Tatters, Rip of Inequality Widens - Eduardo Porter, NYT
National Debt Is on Track to Reach 141% of GDP - John Merline, Investor's
Can 'Helicopter Ben' Save Japan? - Anthony Mirhaydari, The Fiscal Times
The Look of Racial Injustice In Economy - Jared Bernstein,Washington Post
Can Tech Innovation Stop Nuclear Terrorism? - Clifton Leaf, Fortune
Congress Should Watch 'Regulatory Dark Matter' - Wayne Crews, Forbes
tx! My speed reading doesn’t work here, I may have to actually read every word 8P
Why on earth would that be necessary? What I mean is that the vast majority of interest rates are set by folks like you and me that borrow and lend. We are the 'free market'. OK so the Fed does overnight bank rates but their goal is controlling inflation --reason has nothing to do w/ that rate.
These negative rates (which also incidentally have nothing to do w/ the Fed) are what foreign central banks are finding when they borrow --there are people who want to loan their money soooo bad that they're willing to pay those gov'ts to borrow from them.
Weird.
Banksters must be protected from their own folly at all costs. You can’t expect them to take losses on their own stupid actions when they have easy access to other people’s money.
The fed USED to only be charged with supporting the stability of the US system and by extension the dollar. That changed in 77 when the fed was directed to promote maximum sustainable output and employment along with the other charge.
If the rates were set by my and you as you suggest, I would be receiving about 3-4% on time deposits, not .25%.
The monetary and fiscal policy of all nations now is so out of whack, they are all stuck. The banks don’t want any “cash”, they are bribing people to borrow it with virtually free loans. The “cash” is floating around due to the trillions of dollars in deficits run up each year.
Only until a progressive leaves the white house. If Trump is elected the entire system will be allowed to crash. They can’t let it happen on Obama’s watch. Progressivism must NEVER be shown to fail. It will be used to clobber Trump by saying “you see! republicans are bad for the world economy. You need to vote for more Marxists.”
you are right
the next president has been set up to fail.
Obama’s revenge for the “bush’s fault” allegations
meanwhile, should I need to, I can borrow at 4%, same as in say 1970 something
Until government’s seek to balance their budgets, low or negative rates are here to stay. An increase in rates would quickly bankrupt most nations or lead to heavy taxation and/or confiscation of private assets. All of these nations need to curtail government spending and control but, politicians being politicians, I doubt this will happen. They will indulge themselves at the expense of the masses.
They say that a lot of the kids today don’t even know how to handle basic tools. If so they are truly screwed if they ever have to do for themselves.
And you know what: I’m okay if the snowflakes suffer a bit of swim or sink.
Yeah, my wife complains about my supply of non battery powered or electric driven tools. I ask her when she complains about it, what happens if the power does not come on and you need cut a tree or drive a screw?
Negative interest rates are by definition absurd. When you see this kind of widespread absurdity in important institutions you know they are obscuring the truth while the truth is in plain sight. Government debt and the stock markets are unsupported and world institutions have created an elaborate illusion to prop them up.
The only thing surprising about this situation is how long they have been able to maintain the ruse.
Never mind that, do you have an old style fire heated iron for her to use to get your collars crisp the day after next Tuesday? /runsaway
While that may be what you say, most folks who borrow and lend for a living say neg-rates are not absurd at all.
What I'm seeing here is that you don't understand neg-rates and your response to what you don't understand is calling it absurd. Many people do that --it's easy and it inflates the old ego but I try to avoid that easy way out; whenever I see something I don't understand I first accept reality as it is and then I see if I can figure out the 'why' part.
The only major country with an armed populace is still in positive territory. Coincidence? I think not.....
Lots of folks say that and imho it's a dumb thing to say.
Lots and lots of governments are out there borrowing more and more money --they're out renting all the other-people's-money in sight. What that should mean is that all the low rent money should be all snatched up and we should be left w/ just expensive money. iow, gov't borrowing should drive rates up. They're not. What makes more sense to me is that lenders are out loaning money to any gov't in sight making better and better offers for lower cost money --and governments are willing to pick up a good deal when they see it. The result should be low rates w/ more gov't borrowing --this is what we got.
I say the low rates are causing the borrowing, not the other way around.
The end result is predictable: Confiscation of real wealth and physical assets by the government, up to and including the take over and nationalization of industries deemed valuable to the government and their crony interests.
US businesses are so leveraged out right now it isn’t even funny. When the credit-stock-bond bubble pops, it’s gonna make the great depression look like the good old days.
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