Turning Capitalism On Its Head

Earnings troubles and economic weakness continue to spill over into credit markets.  Like equities, corporate bonds have rallied off of the lows of a few weeks ago but default rates are moving higher and credit rating downgrades far outnumber upgrades.  Given the pace of credit deterioration, it would be quite unusual for the corporate bond and leveraged loans markets to not cheapen further in coming quarters.  Importantly, the flatness of the treasury curve with the long bond having remained generally firm should cause one to have second thoughts about taking on credit risk in any major way.  

Because QE did not lead to sustainable economic growth and loan demand is stalling, the central bankers outside the U.S. are pulling out all the stops to try to get markets excited about the negative-rate concept, which turns free market capitalism on its head.  It is stunning how this is being sold as no big deal and just a logical next step.  Europe and Japan have led the way into this strange world where borrowers are paid to borrow.  Japan just issued government debt that yields less than zero and about 40% of the sovereign debt in Europe trades with yields below that threshold.  The ECB just moved further into this no-man’s land of negative rates in last week’s meeting and markets appear to be acting as unenthusiastically as they did when Japan opened the door in the zero floor in January.

In many places around the globe the populace is just plain sick and tired of the monetary regime and endless fiction peddling that passes for leadership and news reporting.  As a result, the central bankers feel an intense need for a new fix to maintain any semblance of credibility, but they are running out of manipulative tactics. Their battle cry has become “QE was such a success that now we are now compelled to try something even weirder to create growth.” We know, it sounds illogical…and it surely is, but they look at the political polls too and see the groundswell of “pitchforks at the door” insurgency that is not just a U.S. phenomenon.  In the U.K., talk of exiting the EU fold is front and center as disgust with the rest of Europe builds.  In Japan, Prime Minister Abe is on the hot seat because after all of the endless rhetoric and QE, growth in Japan remains nonexistent. 

We are also hearing trial balloons about the powers that be taking large denomination bills out of circulation supposedly in a crime-fighting effort.  Obviously that idea must be a result of bankers fearing that depositors will simply pull their cash out of accounts if they are going to be losing money every day that their money is held at a financial institution in a negative rate environment.  No wonder precious metals have been rallying strongly this year. 

Negative rate policy is not being greeted with the desired euphoria by investors because it adds to a sense of unease, as well it should.  Bank stocks, particularly in Europe, have been quite soft for months due to profound worries about loan defaults and now investors must twist their brains into thinking that somehow negative rates will be a good thing for lenders.  We are not the only ones who are not buying it based on comments we hear from bank managements.