The Only Solution to Negative Rates

More than $7 trillion of sovereign bonds and notes are in issue at less than their face value. That means if you buy a German, Japanese or Swiss bond (some as far out as 10 years), you will actually receive less than you paid for it.

Never mind interest payments. You won’t ever collect any of those.

For bond investors, who at the very minimum are used to just getting their money back, today’s markets are a bewildering experience that frankly looks like confiscatory finance. But such are the times we live in, where the world’s central banks have been driven to zero and below as they desperately try to stimulate the G-7 economies.

At no time in history have so many advanced economies flirted with the negative interest-rate policy. So far, the results have not been encouraging. Growth in G-7 has actually declined over the past six months, and all the easy-credit conditions have not spurred additional spending.

Now come two titans of finance to explain why even free money can’t get the advanced economies out of their rut:

Bill Gross – just one of the voices warning on negative rates.

Just this week, Larry Fink, the co-founder of Blackrock, and Bill Gross, the legendary bond portfolio manager, have both warned that negative rates may actually be hurting growth.

> Fink, in a letter to shareholders, said: “Their (central bank) actions are severely punishing the world’s savers and creating incentives to reach for yield, pushing investors into less-liquid asset classes and to increased levels of risk, with potentially dangerous financial and economic consequences.”

Yet in an even more damning insight, Fink states that negative yields may actually hurt consumption because investors must allocate more and more capital to extract yield. This makes eminent sense as lack of cash flow from investments has no doubt curtailed investor income significantly — perhaps even by 50% over the past few years.

> Gross thinks that negative rates are actually a threat to the whole capitalist system. He told Barron’s: “When interest rates get to zero – and that isn’t the endpoint; they could go negative – savers are destroyed. And savers are the bedrock of capitalism. Savers allow investment, and investment produces growth.

“Even in a negative-rate environment, as in Germany or Switzerland, banks and big insurance companies have little choice but to park their money electronically with the central bank and pay 50 basis points.

But an individual can say “give me back my money” and keep it in cash. That’s what would make the system implode. I’m not talking about millionaires or Newport Beach-aires, but people with $25,000 or $50,000. Without deposits, banks can’t make loans anymore, so the system starts to collapse.”

Yet despite the warnings from Fink and Gross, the trend in negative rates is unlikely to reverse anytime soon.

That means that blue-chip dividend stocks — which have already become de facto bonds — will only attract more capital and the whole structure of equity finance may change.

Companies that have preferred to use their cash for buybacks rather than dividend payouts may be forced by activist investors to change their ways as yield becomes king and capital appreciation takes a back seat.

So in our Alice in Wonderland world of finance, dividends may be investors’ only salvation.

Happy trading!

Boris Schlossberg

The chairman of Volkswagen AG and other top executives agreed to large bonus cuts to help resolve a dispute over management pay in the midst of the emissions-cheating scandal, Reuters reports. New Chairman Hans Dieter Poetsch, who was the former chief financial officer, and current management-board members are seeking a “reasonable and fair solution” for bonuses, Germany-based Volkswagen said.

The automaker has been under pressure over executive bonuses after labor unions and the German state of Lower Saxony, the company’s second-largest shareholder, opposed generous bonuses given the financial hit the company suffered from the scandal. Poetsch was in the spotlight because he was entitled to a payment of $11.4 million last year as compensation for leaving the higher-paid CFO post. Volkswagen faces billions of dollars in fines for allegedly installing systems to rig diesel-engine emissions tests. And, it has said the more than $7 billion earmarked in the third quarter of 2015 won’t be enough.

Ford plans to redevelop dozens of buildings in Dearborn, Mich., to create two Silicon Valley-style campuses over the next 10 years, The Detroit News reported. The work represents an investment of more than $1.2 billion, and it will give Ford’s employees the work environment and technology necessary to design and develop cars of the future, the automaker said.

Ford currently has its headquarters off Michigan Avenue, and it has nearly 70 disconnected buildings spread out along Oakwood Boulevard. Many of the buildings are more than 60 years old.

Industrial output in the eurozone declined more sharply than expected in February, but it was still set to register an increase over the first quarter after a strong start to the year, The Wall Street Journal reported. Output of factories, mines and utilities declined 0.8% last month from January, but it was 0.8% higher than in February 2015.

The result was weaker than forecast by economists surveyed by the WSJ, who estimated that output fell 0.5% on the month, and rose 1.3% on the year. Nevertheless, the industrial output may yet help drive economic growth during the first three months of the year. Should that happen, the WSJ said, it would underpin expectations that the region’s economy is set to grow at roughly the same modest pace this year as it did last, despite weaker demand for its exports from China and other large developing economies.

The Money and Markets team