Negative Rates: Why They Are Bad

Includes: KBE, KBWB, RINF
by: Enzio von Pfeil

Direct and indirect reasons why negative interest rates are insidious killers. Investment implications.

  1. Overall critique of creating an excess supply of money
    By now, you must have gathered that we are not friends of Central Banks' abhorrent creation of an excess supply of money. By flushing the system with cash, Central Banks enable politicians to continue their profligacy; why implement structural reforms if Central Banks keep providing more and more liquidity band aids? That welfare museum, Europe is one result; that protectionist mausoleum, Japan, is another. Local politicians have killed their respective business cycles, thanks to the ECB's and BoJ's enabling.

  2. Overall mis-pricing of risk

    Artificially low rates are akin to our Hong Kong parents spoiling their third-generation brats: these enfant terribles know the price of everything but the value of nothing. In plain text: low rates mean that everyone gets to borrow cheaply, so the wrong people get rich for the wrong reasons. Risk cannot be priced any longer by the market, thanks to the Central Bank.
  3. Direct distortions

    In the Financial Times (FT) of 22nd March, p. 9, Morgan Stanley's Huw van Steenis acerbically attacked the direct effects of distorted lending via fake, low interest rates: "Conventional thinking is that negative rates are just a natural continuation of quantitative easing, like dialing down the air conditioning. This, though, underestimates how financial intermediaries may actually respond. They erode banks' margins. They give lenders an incentive to shrink, not grow. They encourage banks to seek out opportunities overseas rather than in their home markets. They also risk disruptions to bank funding. All go against the grain of the central banks' desire to ease credit conditions and support financial stability."
  4. Indirect distortions

    Here is what van Steenis comes up with: "For banks, the indirect consequences of negative rates may matter more than the direct effect. There is a risk that market liquidity will be reduced, as negative rates mean financial intermediaries hoard high-yielding assets. There is also a question of how money market funds, which help many corporates manage their finances, will navigate negative rates. In Japan, all 11 companies running money market funds have stopped accepting new investments. Negative rates, if passed on by banks, could also start to erode consumer trust in banks as the right place for their cash. Sales of safes have risen in German and Japan since they (i.e. negative rates, the author) were implemented."
  5. Investment implications

    Avoid banks! They are too risky and thus offer patchy reward. Instead, hunt for low-cost beacons, financial technology companies ("fintechs").

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