2016-02-03

Negative Interest Rates Are Highly Unstable and Will Destroy the Yen, JGBs

Negative real interest rates exist when nominal interest rates are lower than inflation. In a booming economy, this leads to a credit boom. Although there is an incentive to dump cash, there are lots of incentives to take on debt and invest. This situation can exist so long as inflation does not begin accelerating, at which point the central bank will raise interest rates to arrest inflation rates or hyperinflation will soon follow. The longer the inflation goes on, the greater the credit bubble, the greater the risk of hyperinflation. Pressure in the financial system increases the longer real interest rates remain negative. If it goes on long enough, it leads to currency collapse or banking system collapse.

Negative nominal interest rates are also highly unstable. In a market panic, negative nominal interest rates last for a few months at best as investors avoid bank failures and defaults. Once values are attractive, investors with capital leverage up and buy low. Rates quickly turn positive as the next boom begins.

Central banks theoretically could maintain negative interest rates amid demographic driven deflation. Where prices fall faster than negative interest rates, it's possible to have positive returns. If the population is falling, the price of homes is falling, the demand for credit is falling, thus negative interest rates are steadily retiring the excess credit or currency it doesn't need. In reality, people do not sit tight when asset prices are falling steadily. It would take time to change investor behavior, which reacts to lower expected prices by selling today. Bear markets are rapid because people don't hold a stock with a 10-year expected return of -5%, they dump it today and the price tumbles (and overshoots) until the return is largely positive again.

Negative interest rates will increase over time, but at some point everyone will decide to cut in line and dump everything for cash.

Sales to individuals to be called off over negative yields
The planned March sale of 10-year Japanese government bonds through banks to retail investors, municipalities and others will be canceled amid expected below-zero yields following the Bank of Japan's recent move to adopt negative interest rates.

The Ministry of Finance is expected to announce Wednesday the first-ever decision to call off sales of 10-year JGBs.

...Corporations and municipalities have started delaying their own issuances. Daiwa Securities Group has dropped plans to set conditions later this week for the issuance of seven- and 10-year straight bonds this month. The brokerage decided to take a fresh look at JGB yields and investor demand and said it has not decided when to proceed.
There is a word for slower and falling credit issuance: deflation.

FT Alphaville: Japanese banks don’t like something
Further weakening the yen may have a more material impact on Japanese exporters and on the banks as it boosts their overseas profit contribution in yen terms. But it leaves them reliant on capital gains from their QQE supported investment portfolios while the core profit margins shrink further. As it looks likely to weaken their core profitability the move is negative for the banks.
Without a weaker yen...

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