When Austria sold a €3.5bn 100-year bond two years
ago at a yield of just 2.1%, a few eyebrows were raised. Today, buyers who had
handed over cash in that sale could be forgiven for feeling a bit smug.
The bond is among the best performing assets in the
world this year, notching up a total return of nearly 66% since the end of
2018. Nearly half of the gains have come since June, when Vienna raised a
further €1bn in a follow-up sale of the same bond at an even stingier
yield of 1.2%.
Debt markets around the world have rallied in 2019.
However, it is longer-dated bonds that have been the outstanding performers.
That is a function of their high duration — a measure of the sensitivity of
bond prices to moves in interest rates. For ultra-long bonds, even a small dip
in yields means massive price gains that dwarf income from coupon payments.
German 30-year bonds, which have recently seen their
yields turn negative, have returned 28% this year. Holders of UK 50-year bonds
are sitting on a 22% gain.
Not all countries issue ultra-long-dated debt. The
longest bonds sold by the US and Germany are their 30-year benchmarks. Within
the eurozone, Austria, Belgium, France, Ireland, Italy and Spain have all in
the past five years capitalized on investors’ thirst for yield by selling bonds
maturing in more than three decades.
Generally, demand for these bonds is dominated by
pension funds and insurers that need long-dated assets to match their
long-dated liabilities — and are typically less concerned with yield levels
than other investors.
But Austria’s century bond was an exception, with
asset managers accounting for nearly two-thirds of orders, suggesting that many
buyers were using the bond to take an outsize bet on lower rates.
China’s trade war with the United States has
escalated in recent days, posing a growing threat to an already slowing
economy.
China is not running out of money. But Chinese
banks are reluctant to lend to private businesses because they
consider big, state-owned enterprises more reliable in paying off their debts.
Alternative sources of money have dried up as regulators have cracked down in
recent years on China’s shadowy world of unofficial lending.
So a growing number of companies are issuing i.o.u.s
to their suppliers. Some suppliers turn around and use the notes to pay another
supplier. And then — in a sign of how desperate some Chinese companies have
become for money — they sell the notes for less cash than they are worth.
Commercial acceptance bills are not legal tender.
Rather, they are pieces of paper promising payment in the future. Companies
owed some $211 billion in these informal notes as of February, the most recent
government data available, an increase of more than one-third from the previous
year.
More debt may be floating around China’s corporate
world and goes untracked if the notes are being traded for less than their face
value. A market has formed around commercial acceptance bills, in which
companies buy and sell them based on the prospects for being paid back. The
bigger and better known the company, the more secure the bill is considered.
A pillar of China’s economy, the property sector, is
feeling the squeeze particularly hard. Sales have been slowing since late 2017,
making it hard to pay for new projects. At the same time, the government is
clamping down on other ways that property companies raise money, like through
the shadow banking system.
Property companies have adapted by effectively
turning the commercial acceptance bills into a currency, according to
interviews and filings from dozens of property developers and suppliers like
steel companies, design and construction firms.
Xu Jiang of Zhubo Design, an architecture and urban
planning company in the southern city of Shenzhen, said customers had started
to pay with commercial acceptance bills two years ago. The customers, which
include some of the country’s biggest developers, local governments and
state-owned firms, now use these notes more frequently than paying cash, he
said.
Today, one of the biggest issuers of i.o.u.s is China’s largest and best known property company, Evergrande ($36bn market cap). By the end of last year it had issued nearly $20 billion worth of i.o.u.s to its suppliers. With a towering $100 billion debt pile and a penchant for raising bonds to pay off the interest, it appears to have turned to commercial acceptance bills to help cover costs.
Bauing Construction Holding Group, a big supplier of
design and materials to China’s biggest property developers, has disclosed that
it is owed $96.4 million in these i.o.u.s from Evergrande.
Another company that owes Bauing money is the
state-owned firm China State Construction Engineering. China State said it had
owed $490 million in i.o.u.s to all of its suppliers at the end of last year.
Another major property developer, Greenland
Holding, which was founded by the Shanghai government and has property
developments in dozens of cities across China, had $550 million worth of unpaid
notes out to suppliers by the end of last year, according to its annual report.
The company said that was 10 times the amount it had outstanding in 2017.
African swine fever, a highly contagious virus, has
spread to every province in China. The country is the world’s biggest pork
producer, and home to half the pigs on the planet. In the last year it has
reported 149 outbreaks. Some 1.2m pigs have been culled, according to official
statistics. Unofficial reports suggest far bigger losses. Rabobank, a Dutch
bank, reckons that by year-end, as many as 200m pigs could be lost to disease
or slaughter, leading to a 30% drop in pork production.
Although African swine fever is not harmful to
humans, it kills up to 90% of pigs. Infected animals stop eating, hemorrhage
and die, often within a week. There is no vaccine or cure. Before 2007 the
disease had been eliminated from most of the world, with the exception of
Africa. It reemerged in Georgia in early 2007 and spread to Russia, Ukraine,
Belarus and Lithuania.
The disease was probably introduced to China via its
northern neighbor, with which it shares a 4,300km (2,670-mile) border, or
through infected pork products imported from Europe.
China’s first outbreak was reported on August 3rd
2018 in Liaoning, a coastal province in the north-east of the country. Chinese
authorities scrambled to contain the disease, culling tens of thousands of pigs
and banning transport of the animals into and out of affected areas. It did not
work. The virus spread to every part of the country. It eventually crossed into
neighboring Vietnam, Cambodia and Laos.
With pork prices in the country expected to jump by
70% year-on-year in the second half of 2019, China’s favorite meat may soon be
off many dinner tables.
After almost three decades of near-zero, zero, and
now negative interest-rate policies, Tokyo has pushed its banking system to its
limit.
The country’s smaller lenders in particular are
facing an existential threat to their business models. Located in aging and
shrinking prefectures, they lack the ability to increase fee-related incomes
that major banks can raise.
Since March 2016, shortly after the country’s
negative interest rate policy was introduced, net income at major banks has
declined by a fifth. At regional banks, the decline has been steeper: Net
income is a third below its level three years ago.
Practically all of Japan’s regional banks have seen
their share prices fall in the past 12 months. More than half have had declines
exceeding 30%. They have underperformed the broader Japanese market for
decades.
At the beginning of 1995, just before the Bank of
Japan cut its benchmark policy rate to 0.5%, loans by commercial banks with
interest rates of below 1% were practically nonexistent. Over 90% of
outstanding loans carried an interest rate of 3% or more. Today, 90% of
Japanese loans carry an interest rate of less than 2%. The fastest-growing
segment is the paltry 0.25% to 0.5% bracket, which has expanded by almost a
10th in the past year.
The interest offered to Japanese depositors, however,
shifted much more quickly to very nearly zero. The upshot of this is that
profitability held up for a while but now the 1.5 percentage point spread
between interest rates on new loans and new time deposits that prevailed in the
1990s has declined to just 0.5 percentage point. Even with the country’s
rock-bottom default rates, the resulting profits simply aren’t sufficient to
run a bank.
Some of Japan’s major banks have found an apparent
workaround, but one with its own serious risks. Those with the expertise and
ability to do so have ventured overseas, acquiring assets and lending in
currencies without such low interest rates.
The precarious position of Japanese banks isn’t an
example of negative interest rates failing but of them working perfectly well.
Central bankers often complain about problems with monetary transmission—often
a byword for banks not passing on interest-rate cuts—but Japan’s have done so.
Critics of Japan’s monetary policy would be wrong to
imagine that higher interest rates would help either. As with lower rates, the
change would take years to filter through, during which time defaults would
rise and economic growth would stall.
A developer, Misuma Limited, is selling a £2.1m house
in Kentish Town through a housing competition. To enter, you pay £10, plus a £1
booking fee. You then receive a ticket, which, if you win, entitles you to the
house.
The competition…will run until the end
of the year. More details on winmydreamhome.com.
Housing competitions – an alternative and
controversial way of selling a property, wherein the business model of the
casino is disguised as a charitable endeavor – have kept cropping up over the
past few years.
They typically involve a question, which is a legal
requirement, because otherwise a competition that charges for entry and selects
a winner at random is a lottery, which requires a license.
What’s slightly different about winmydreamhome.com is
that it’s run by a developer, rather than a random individual who can’t sell
their house. Marc Gershon, a director of the company, told us the plan is to
“clean up” the housing competition space.
So what are the odds? The fine print is quite
important. If less than 250,000 tickets are sold, then the house is not given
away at all; instead, the competition gives away 60% of the prize pool. If more
than 250,000 are sold, the house is given away, and stamp duty of £165,6000 is
paid. In each case, the business pays 10% of the proceeds to charity.
Misuma has three other flats in development. If the
first competition goes well, they’ll look to also exit those developments
through a competition. But what we initially thought was simply a quirky
publicity exercise turns out to subtly reflect the rising pressures on
small-scale London developers post-Brexit.
Even if the project fails, you have to admire its
extraordinarily subtle capacity to bring together two concepts – gambling, and
London housing – that no one would surely ever have associated with each other.
Despite what you see
on TV, through streaming, or in the movies, teenage drug and alcohol use in the
US is actually down…with the exception of marijuana.
And while I know I
had the chart from Pew Research on population projections in 2020 and 2100
(report is from June 17, 2019), it’s worth pointing out the sheer change in
populations by 2100. Seriously.
UBS plans to levy a negative interest rate on wealthy
clients who deposit more than SFr2m (USD $2M) with its Swiss bank, as lenders
hunker down for a period of ultra-loose monetary policy.
Several banks in Switzerland and the eurozone already
pass on the cost of negative official rates to corporate depositors, although
most large players have refrained from doing so with individual clients.
But with policymakers expected to adopt a “lower for
longer” stance for the foreseeable future, UBS Switzerland will from November
charge 0.75% a year on individual cash balances above SFr2m, according to three
people briefed on the plans.
The move underscores how banks in Europe and the US
are scrambling to prepare for a protracted spell of lower rates that threatens
their profitability, having previously wagered that central bankers would
tighten monetary policy.
“We assume that this period of low interest rates
will last even longer and that banks will continue to have to pay negative
interest rates on customer deposits at central banks,” UBS said. “Following
similar moves by a number of other banks here in Switzerland, we confirm that
we’ve decided to adjust cash deposit fees for Swiss francs held in
Switzerland.”
The move comes as Credit Suisse, UBS’s main rival,
said on Wednesday it was also thinking about imposing a levy on some wealthy
clients.
And
now an extremely insightful piece from Robin Harding of the Financial Times.
This one is in its entirety with some emphasis made in bold (mine).
This will be a discomforting, defining week for the
global economy. That is not because the US Federal Reserve is set to cut
interest rates. Rather it is because of the strikingly low level of rates from
which the Fed will start: a range of just 2.25% to 2.5%.
After more than a decade of economic expansion, and
despite everything from tariffs to tax cuts, it seems this is as high as US
interest rates go. Meanwhile, the European Central Bank is debating whether to
reduce its negative rate still further. Until this month, it was possible to
imagine that pre-financial crisis levels of 4% to 5% might eventually return.
No longer.
According to their own projections, Fed officials
believe rates will settle at 2.5% in the long run. Subtract their 2% inflation
target and the real reward for capital is going to be a miserable 0.5%. The
equivalent rate in Europe and Japan will almost certainly be much lower. Such
low levels of interest rates are a profound change from the past. (The federal
funds rate was 6.5%, and the real rate was about 4% as recently as 2000.)
Although interest rates touch almost every aspect of economic life, the developed
world remains deep in denial about the consequences. Here are eight themes for
investors and policymakers to ponder.
First, there is an intimate link between long-run
interest rates and long-run economic growth. Perhaps capital is less relevant
to the digital economy, but for interest rates to max out at such low levels
sends an alarming signal about the prospects for future expansion.
Second, monetary policy is broken. In 2008-09, the
Fed cut rates by 5 percentage points and it was not enough. Today it has far
less room to respond to a recession. The Bank of Japan, which made no move on
Tuesday, has all but given up trying to hit its 2% inflation target. The ECB is
in danger of going the same way. The world is dismally unprepared for a
downturn: two of the world’s most influential central banks may start the next
recession with their policy rate already below zero.
Third, if monetary policy is broken,
fiscal policy must step in. That means either governments must approve higher
spending and tax cuts in response to a recession or else give the central bank
a fiscal tool in the form of “helicopter money”, essentially printing money to
spend or distribute to the public.
Alternatively, governments could set higher inflation targets and use fiscal
policy to reach them now. That would give their central banks more room to cut
when they need it.
Fourth, lower interest rates make
debt more sustainable. This is particularly true for public debt, because
countries actually borrow at these low risk-free rates, and somewhat true for
private debt. For many countries, it makes sense to borrow more in order to
invest. Predictions of financial crisis based on past levels of debt-to-gross
domestic product are likely to be misleading.
Fifth, capital stock should rise
relative to output. Investments that were once unprofitable now make sense:
road upgrades to save a few minutes of time; expensive, niche drugs to help a
few hundred people; or extra years of study to earn a graduate degree. Such
projects may feel irrational. They are not.
Sixth, any asset in fixed supply is now more
valuable, because its future cash flows can be discounted at a lower rate. A
monopoly supplier of water or electricity, land in a city center or the back
catalogue of Disney: the capital value of these assets must rise, so their
yield matches the lower interest rates. This trend is related to recent
movements in wealth inequality. It also puts investors at risk of identifying
financial bubbles that do not actually exist. One vital policy response would be to slash the return
on capital allowed to utilities.
Seventh, demand for housing will rise. It is, after all, the main capital asset that most people use. There are two potential outcomes. Where it is possible to build, permanently lower interest rates will trigger an increase in the housing stock. If it is not possible to build, then houses will behave like assets in fixed supply, and soar in price. Thus falling interest rates make planning and zoning rules a crucial economic issue.
Eighth, low interest rates make it harder to save. In
particular, they make it harder to save for a pension, and harder to live off
whatever capital accumulates. This fact has been obscured by the one-off rise
in price for scarce assets, many of which are owned by pension funds. But
future returns are likely to fall. The result will force workers to accept some
combination of later retirement, higher taxes, bigger pension contributions or
lower incomes in old age.
It is possible that this bout of low interest rates
will end. Perhaps the Fed is mistaken and it will have to raise rates sharply
in the future. Perhaps a burst of technological progress will raise growth and
boost demand for capital.
But no one can choose to make that happen: this is not some perverse plot by Fed chair Jay Powell and ECB president Mario Draghi to make life miserable for the world’s savers.The long-run real interest rate balances the desire to save and demand to invest. Central banks are its servants not its masters.
The trend towards lower real
interest rates has lasted for decades and is as likely to continue as to
reverse. With central banks moving to ease, it is time to stop waiting for
rates to recover and face the world as we find it.
