All Forum Posts by: Bob Houston

Hi Gene - Yes - negative rates are a sign of deflation. There's a couple of painful ways out of it - and I think that's the problem - everybody wants a fix without the pain - and it's impossible. Solution #1 - Austerity - it would eventually turn the ship around - but that's 5 or more years of under-consumption, increased savings and paying down debt.. living below our means - which means a sustained weak economy (high unemployment, demand destruction and a slow leak in asset prices). It would eventually set the stage for another healthy expansion. Solution #2 - Defaults on the massive pile of debt. This would be a quicker fix - but more painful. I think we're going to get a combination of the 2. Regardless - I don't see a way out of the current situation without some pain. The solution coming out of the GFC in 2009 (massive debt injections), won't work now.. that's exhausted - and the bond markets are telling us this.

Here is a link to a recent great podcast by the brilliant Dr. Lacy Hunt discussing the above.
https://podcasts.apple.com/us/...

Thanks Gene

If the Fed pushed overnight rates to zero and nominal 10 year rates went negative it would mean the deflationary environment is accelerating - which mathematically would mean "real" rates are rising and the risk premium on loans would spike. Coupled with that would be a severe reduction in loan issuance which would push M2 negative and velocity would collapse, resulting in an acceleration in negative GDP (negative feedback loop). That's the banking side.  On the "assets" side - with the positive carry on the 10 year note now gone - leveraged risk parity funds would have to unwind, which would cause a sustained and massive collapse in stock markets. In short - negative rates in the U.S. would be an end game scenario. Real rates are currently negative - that is a deflationary environment..

You're correct - some of it is monetized - in bank reserves. An institutional investor will park in negative yielding debt for liquidity purposes - with the idea, under the current environment - it's the safest place to park large amount of funds short term. As retail consumers, we've been parking our money in negative yielding checking accounts at banks ( no interest and monthly fees) for a while now. Seems to be better than under the mattress.
There is some foreign capital coming into U.S. treasury's - that's why we're continuing to see the yields get pushed down. Foreign investors have an extra cost of carry with FX hedging - which pushes their yield down even further - and in some cases negative on U.S. debt. Regardless, one of their biggest concerns is liquidity.
I managed a derivatives based hedge fund for 20 years (retired now). When people asked me what I did I told them I traded liquidity and managed risk. Liquidity is paramount with large sums of capital.

Please know, no bank is every going to "pay you" to take out a loan - no matter how negative interest rates could go. Negative interest rates are an articulation of an economy slowing collapsing. Institutions (lenders) can live with negative interest rates for a certain amount of time - but must eventually come out. An institutional investor will park itself in sovereign negative interest rate debt with the idea that there may be a capital gain if interest rates sink even lower. Bottom line - a negative interest rate environment mean economic demand destruction / deflation / high unemployment / negative GDP. Everybody talks "V" shape recovery - but the yield on the U.S. 10 year note at .60bp tells the true picture... The economy is in dire straits.