Follow what they do… not what they say

Follow what they do… not what they say

Are you prepared for a negative interest rate Australia?

I’m not.

In fact, it’s something I find impossible to compute.

The Aussie economy has never used negative interest rates.

Yet, certain institutions around us are implying that they are preparing for that.

Is it possible that Australia will join the likes of Japan and Switzerland, and force minus interest rates on their people?

Topsy-turvy world of bonds

Grant Williams, editor of the blog Things That Make You Go Hmmm, stood up at the Sprott Natural Resource Symposium and told the room there was US$14 trillion worth of negative-yielding products worldwide.

What are negative-yielding products?

Traditionally, a bond holder (an entity that bought the bond) receives income earned through interest, at a set time. In simple terms, it’s a way of receiving money for taking the risk to lend money to a company.

Let me put it this way. Imagine you lend me $10 today. And in one year’s time, I give you back $11. That means you have ‘earned’ $1 in interest for lending that money today.

However, a negative-yielding bond is the flip side of that.

A negative-yielding bond means the company that issued it is being paid to create debt.

So rather than receiving income, the bond holder is now paying for the privilege of lending money to a corporation.  

In dollar terms, if you lend me $10 today, a year from now I would give you back $9.

It’s absurd. There’s no way you would lend me money today only to receive less in a year’s time.

Yet, there is US$14 trillion of those sorts of deals floating through the financial system today.

It’s highly unusual, and stupendously risky.

Yet, it’s becoming increasingly common within the global financial system as negative interest rates take hold.

Right now, this is only a problem for other countries. There’s no way Australia would follow suit.

I mean, our central bank is smarter than that, right?

How the mighty have fallen

Bloomberg has done a deep dive into the Aussie economy.

Well, its analysis combined Australia and New Zealand into one, but we can forgive it for that just this once.

Bloomberg noted the days of the ‘rock star’ economies in the Southern Hemisphere are soon to be over, writing:

Their economies were separated by the Tasman Sea and little else: both were geared to the China commodity story and both managed to resist the descent into negative interest rates and bond buying.

How the mighty have fallen.

Australia and New Zealand now find themselves with just 1 percentage point of conventional monetary policy remaining. That’s around the same level the Federal Reserve and Bank of England had when they turned to quantitative easing to support moribund demand following the 2008 financial crisis.

New Zealand’s 50 basis point interest-rate cut Wednesday and Australia’s back-to-back easing in June and July suggest both have joined the global race to the bottom. Policy makers across the world are looking for every bit of stimulus available and currency depreciation is an obvious one.[1]

As both our central banks race towards zero, I can’t help but notice the different tone between the two governors.

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Take RBA Governor Philip Lowe, for example. After the first rate cut in almost three years, Lowe told the market: ‘I am very hopeful that we will not need to go, certainly into negative territory, or to these very low interest rates that the Federal Reserve Bank and the Bank of Canada got to.

How he said that line with a straight face is beyond me.

As of today, Australia is only four rate decisions away from matching both of those countries’ (the US and Canada) ‘emergency’ policy decisions.

Furthermore, Lowe’s comments are in stark contrast to what Adrian Orr, Governor of the Reserve Bank of New Zealand (RBNZ), uttered overnight.

On the back of the RBNZ’s unexpected decision to drop rates by 0.50% to 1%, Orr said:

We would be negligent not to be doing the work as to how we do negative interest rates, how we might do asset purchases, how we might do forward­ guidance and how we might do other forms of intervention.[2]

Yes, our neighbours across the ditch told the market that negative rates and their workings are on the table.

Not only that, but Bloomberg pointed out that ‘Traders and economists are tending to lean toward the RBNZ’s assessment over the RBA’s.

Turns out, everyone outside Australia doesn’t believe the RBA anymore…

ASX war-gaming negative rates

Our Kiwi cousins are talking about a world of negative rates.

And our own central bank has its head in the sand about what’s possibly ahead.

Or, perhaps it wants you to have your head in the sand about what may come.

Regardless of whether negative rates are still a thought bubble or not, the Australian Securities Exchange isn’t taking any chances.

Last month, it was revealed the ASX is preparing for a world of negative rates.[3]

The Australian wrote:

Due to the declining interest rate environment, ASX has been investigating the impact of zero and negative interest rates on all ASX interest rate products — including futures and options over futures — and relevant ASX systems.

Basically, our own bonds and futures markets, which run through the exchange, currently only have infrastructure in place for products with a positive interest rate.

Yet they’ve read the tea leaves, and have realised they better update their computer systems to accept negative rates on certain products.

When this digital infrastructure was created, the idea that interest rates would be in negative territory seemed obscure.

Our exchange is facing a Y2K-type programming problem, but for interest-bearing products.

And that’s where we find ourselves today, folks.

Our central banks and stock exchanges are prepping for negative interest rates.

The RBA says it’s not probable.

The RBNZ reckons it should at least look at how it works.

And the ASX is jumping the gun and making sure it’s ready for it, if it comes.

Investors should also prepare for it.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia