Finance blog


Strange Days Indeed

March 03, 2021

I have been watching with fascination for several years now the unreal reality of negative rates in various countries. I keep thinking it has to stop. It just doesn't make logical sense that a government should be able to issue debt and get paid for it. According to Bloomberg, as of today, there are 18 countries that have 0% or lower rates on their 5-year notes.

Take a moment to look at the top of this list: Germany. The German 5-year note has been issued with a 0% coupon and is currently trading at a price of $103.385, corresponding to a yield of -0.65%. In plain English, you can spend 1,033,850 today to get back 1,000,000 in April of 2026. What a deal!

However unreal, this has been going on for a very long time now- first in Japan and then in the Eurozone.

How and why does this happen? The basic idea is that central banks use this ultimate financial tool to spur massive borrowing, hoping to increase business investment and ultimately to spur inflation. Another expected outcome is a devaluation of the currency in question, with the expectation of increasing foreign investment, tourism and export sales. Many central banks have not only initiated a negative central bank overnight rate, but they have also aggressively started buying their longer-term sovereign debt—and we can see the results above.

This is, of course, very painful for banks. It actually turns the whole concept underlying banking, namely borrowing money at a lower rate and then lending it out at a higher rate, on its head. How can we even imagine taking in money at a negative rate and then loaning it out at a less negative rate? Think about that for a minute: you would be actually getting paid a rate to borrow money, and then theoretically pay someone else to borrow it from you. In the case of Denmark's Jyske Bank, beginning in 2019, they actually offered a negative mortgage rate, whereby a borrower would buy a house and then receive monthly mortgage payments. The rate was quoted as a 10-year loan at -0.5%. Borrowers would pay principal, less interest.

While all of this is interesting, it's kind of old news. Rates have been negative at some of these central banks since 2014. However, something big happened in Germany recently.

According to the Wall Street Journal, many of Germany's banks have decided it is time to start charging retail customers to hold their deposits. These banks include Deutsche Bank AG, Commerce Bank AG, and 237 smaller institutions around the country. Currently, these fees, as they characterize them, range between negative 0.40% and negative 0.60%.

In some ways, this makes sense. As you can see in this graph from the St. Louis Fed, commercial bank deposits have been surging since the pandemic began. People are not going out to eat, traveling, shopping, and the like in the U.S., and from what I've seen and read, the lockdown is even more restrictive in much of Europe.

So, while in the U.S. we've seen a deposit bump, the trend has been greatly magnified in the Eurozone, where bank deposits have surged from around 885B euros to nearly 5T euros. How tough must it be to make money as a bank in that environment!

If you have been reading this blog for a while, you have probably noticed a tone over the past several months expressing concern over potential inflation.

As I've noted in earlier posts, the yield on the U.S. 10-year has indeed been ticking up lately (currently yielding 1.41%). Oil and gas prices have also increased, and new home prices, especially in lower property-tax states, have been rising. Offsetting this home price appreciation have been a drop in rents in some larger cities and weakness in commercial real estate values. There are many powerful forces at work right now as the new normal begins to solidify. Thankfully, our FED has taken the approach of not trying the negative rate scheme, perhaps because there are clearly so many problems with that approach, not the least of which would be incredibly destructive pressures on community banks and credit unions.

That's it for now, at least. To ignore what's been happening across the pond would be silly, and this blog won't.

Final, final thought: It's only 20 degrees this morning here in Chicagoland, but some of the snow has melted over the past few afternoons, and I can actually see grass for the first time in almost 30 days! Spring might actually be springing.

Be sure to fill out the form below to subscribe to my weekly blog.