- Irish pension funds now being charged to deposit money
- US 10-year treasury at all-time lows (below 60 basis points)
- Keep an eye on the flattening yield curve
There was a story which appeared last week (July 31) which has not yet received a lot of mainstream attention…
But it deserves a closer look:
In short, the Bank of Ireland is their first bank to start charging pension funds for holding cash.
It’s a huge shift… and I suspect other major Irish banks will follow.
And whilst banks have been doing this to large institutions and corporations since 2016 – they have held back on going after people’s pensions / life savings.
Until this week…
Ireland is now charging pension funds 0.065% for any cash held. Here’s the Irish Times:
European Central Bank interest rates have been negative since 2014,” the bank said in a statement.
“Since then banks have been subject to negative interest rates for holding funds overnight and market indications are that rates will remain low for some time.
“As a result we have applied negative rates on deposits for large institutional and corporate customers since 2016.
“We recently wrote to 14 investment and pension trustee firms to inform them about a rate change to their accounts, which is reflective of the negative interest rate environment.
” … It is no longer sustainable for the bank to continue with the current rate of interest”
So here’s our ‘exam question’ this week – could this come to the US and other developed economies?
Yes it’s possible….and perhaps likely.
Now the reason I say this is not to be alarmist… but to call your attention to perhaps the most important chart in global finance – yields on US 10-Year treasuries
US 10-Year Treasury Yield – Aug 3 2020
Could We See a Negative US 10-Year Yield?
First up, it’s worth calling out that we have never seen the yield on the US 10-Year Treasury this low.
And from mine, this is a reflection of the (insane) levels of debt “we” have elected to take (and seem hell-bent on adding to).
For example, at the time of writing, Congress is debating on whether to pass an additional $3 Trillion stimulus bill (which is incremental to the $3 Trillion already passed).
Now recently Fed Chairman Jerome Powell insisted that the Fed is not looking at negative interest rates as a potential monetary policy tool (unlike his European counterparts).
However, if we look at the trend on the chart above, to me it feels quite probable that’s where we are going (regardless of what Powell tells us).
Even if the Federal Reserve doesn’t employ a negative interest-rate policy, global demand for U.S. debt could pull short-term Treasury yields below zero in coming years.
More than $13 trillion of global bonds have negative yields, according to ICE BofAML Indices.
In other words, investors are agreeing to take small losses to stash their money.
Now in theory (but perhaps not reality) – the Fed can only print so much money (without running risks of longer-term extreme consequences; e.g., potential dollar devaluation and high inflation)
However the problem (as we have been writing for years) is each new dollar in credit has decreased effectiveness.
And hence why we see a chart like this:
US Federal Public Debt (Blue) vs GDP (Orange)
Public debt screams higher (blue line)… and yet output (GDP) fails to maintain the same pace.
Put another way – it now requires almost $5 in new credit just to generate $1 in output.
That’s not a sustainable path… especially should rates rise.
What’s more – should we see credit contract or stall – GDP plummets.
The bottom line here is as treasury yields continue to fall (determined by market forces; e.g., a higher demand for treasuries) – then the Fed will ensure that short-term rates will stay near zero for “as long as it takes”.
But that presents another problem…
Banks Struggle with ‘Flat’ Yield Curve
The problem with this of course is in the banking sector…
Banks are primary in the “lending” business.
The business of lending depends heavily on the price of money (i.e., interest rates in their case)
Traditional bank’s business (or profit) model is straightforward:
- buy money at the short-end (i.e., a rate set by the Fed); and
- sell money (i.e. lend) at the long-end (i.e., set by the bond market).
The difference is their profit less their costs of doing business.
Now when the long-end (e.g., US 10-year yield) is near zero (or negative) – it’s extremely difficult for banks to make money.
For example, today we find the difference between the 2-year and 10-year treasury yield is approx 45 basis points (thanks to the Fed anchoring short term rates at zero)
US 2/10 Year Treasury Yield Curve
And generally – when this chart turns negative – a recession is not far away (e.g., within 12-18 months on average).
It turns out – this yield curve turned briefly negative in August of 2019 (well before we learned of anything called COVID-19)
Negative rates are not something to wish for.
If rates turn negative – something is horribly wrong. The private market cannot work with negative rates.
Alan Greenspan said last year that “negative is just a number”
That’s bullshit.
And whilst negative rates are not yet on US shore – don’t think they may not come.
The takeaway folks is your cash is trash.
Central banks hold ‘virtual gun’ to savers (and pension funds) heads in the form of zero rates.
In other words, you are forced to take more risk to generate any form of return.
Call it ‘collateral damage’.
As I have explained in previous posts – this is a major reason shares are considered “attractive” despite extremely stretched valuation multiples.
In other words, what alternatives to investors have?
Finally, it also helps explain why gold is soaring to record highs…. which is likely to continue.
Regards
Adrian Tout
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