A lot of noise has appeared in the last few weeks on the effectiveness of recent central bank policy, namely quantitative easing. Whilst this has been an important part of the recovery since the banking systems near collapse, the benefits of continuing this policy look to now be outweighed by the costs.
Here are a few interesting snapshots on negative rates.
As a consequence of negative interest rates on the cash held in Swiss bank accounts, local authorities (cantons) prefer that the public delay paying. It costs the cantons money if people pay at the start of the tax window.
Interestingly, everyone wants to pay tax as early as possible.
We wonder how this could go further. If you were a business with invoices due, would you prefer customers delay paying? If you trust their credit rating and don’t have a cash flow constraint, you might.
It also presents an interesting issue for invoice financing start-ups. Will they need to pay companies for the privilege of getting people paid faster?
We note that credit spreads (default risk) should still keep SME lending rates positive but negative rates do reduce margins in some way.
Coming to all home owners soon! I expect a few people have similar mortgages in the UK. I remember a friend obtaining a mortgage 30 basis points lower than the BoE base rate in 2006, which would be negative now if she hasn’t refinanced.
As central bank cash rates and even long-term bond yields go negative, you are essentially rewarded for taking on leverage and house-price risk. Seems a bit odd that the result of trying to repair leveraged speculation on house prices is to reward people with cash payments for taking speculative leverage on house prices.
The ECB’s CSPP (buying corporate bonds) has had a few words of warning from Bank of America analysts. As BB rated bonds, which are below investment grade, have increasingly negative yields we see a shift in borrowing and acquisition metrics.
Firstly, gaming any interest coverage test becomes easy. You no longer need to care about Interest/EBIT multiples as you will be paid for the leverage. Existing buyouts then have more room to increase leverage and new LBO opportunities become available.
Companies will look to acquire more targets, ideally with strong collateral values, as owning a liability on collateral (in the same way as the Danish couple with a mortgage) is a money earner. You are rewarding those who believe in future price increases or stability.
In the ECB’s case, this makes sense: the fear of deflation is creating opportunities for those who are willing and able to help the ECB fight all deflationary pressures.
Sadly, many of these problems might be due to prior price increases being brought forward by earlier monetary policy: central banks might be chasing growth that has already been taken through lower interest rates and earlier rounds of quantitative easing.
In the meantime, enjoy the free leverage. Just make sure you can run to the door when the music stops playing.
Thanks to Bruegel and Bloomberg/BofA for the charts.