Lower Interest Rates Are Symptoms, Not The Cure

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Includes: BBCA, ENZL, EWC, FCAN, FLCA, HEWC, QCAN
by: Danielle Park, CFA
Summary

The New Zealand central bank slashed its official cash rate by a third Wednesday - to one percent - and twice as much as expected.

We expect the Bank of Canada to also abruptly shift to a rate cutting effort in the weeks ahead.

The fact that banks and investors are willing to make zero and negative-rate loans and buy negative-yielding treasuries is also not bullish.

The New Zealand central bank slashed its official cash rate by a third Wednesday - to one percent - and twice as much as expected. In response, the New Zealand dollar (NZD) slumped nearly a percent and is back under .65 per U$. The NZD bottomed the last cycle at .48 in the spring of 2009. Entering this global downturn with a bank rate near zero, and a population struggling with record indebtedness, monetary easing is much harder to effect than in past cycles. Here is a direct video link.

We expect the Bank of Canada to also abruptly shift to a rate-cutting effort in the weeks ahead. The Canadian dollar was down to . 75/U$ Wednesday and may well head into the .67/U$ range in the months ahead as the economic cycle bottoms.

In the next iteration of desperate: this week in Denmark, banks began issuing 10-year mortgages at a rate of negative .5%, 20-year mortgages at zero-interest, and 30-year mortgages at just 1/2 percent. Imagine. Banks paying people to borrow money. Try and find that one in the finance textbooks.

These are certainly not signs of strength. You can make loans free, but people can't take on more debt where they lack the income to repay principal, and the value of their existing real estate is stagnant and falling. Flat wages and falling revenue among heavily-indebted populations are problems that central banks have helped to make, but cannot fix.

The fact that banks and investors are willing to make zero and negative-rate loans and buy negative-yielding treasuries is also not bullish. It's a symptom of wildly overvalued asset markets and a world slipping deeper into liquidity crisis. Sober capital is seeking least damaging options given present downside risks and the prospects of a slow recovery. See 20-year mortgages hit zero for the time in Danish history:

"It's an uncomfortable thought that there are investors who are willing to lend money for 30 years and get just 0.5 per cent in return…It shows how scared investors are of the current situation in the financial markets, and that they expect it to take a very long time before things improve."

Disclosure: No positions.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.