Negative Rates and Negative Yields and the Next Financial Crisis (featuring: Thanos)

In this tutorial, you’ll learn what the trillions of dollars of negative-yielding bonds means, why it’s a sign that central banks have manipulated the financial markets, and why it just might result in the next financial crisis.

Resources:

https://youtube-breakingintowallstreet-com.s3.amazonaws.com/Negative-Rates-Negative-Yields-Slides.pdf

https://youtube-breakingintowallstreet-com.s3.amazonaws.com/Negative-Rates-Negative-Yields.xlsx

Table of Contents:

1:39 The Short Answer – Central Banks Gone Wild

3:25 Why Buy a Negative-Yielding Bond?

12:45 What Are Central Banks Thinking?

15:07 The Endgame

16:58 Avoiding the Carnage

18:16 Recap and Summary

SHORT ANSWER:

Negative interest rates make no economic sense and hurt banks, consumers, and the entire economy by mispricing risk, resulting in asset bubbles and unproductive investments.

Negative yields on bonds are also signs of a bubble, but they may make *a little* more sense in certain contexts.

None of this is natural – it’s a direct result of central banks manipulating markets by setting interest rates to artificially low levels.

Why Buy a Negative-Yielding Bond?

The short answer: because you anticipate that market yields on similar bonds will fall even more in the future, as central banks make interest rates even more negative, so the price of your bond will rise.

So, even if you earn no interest or *negative interest* on the bond, you might be able to resell it in the future for a profit… as long as people still expect yields to keep falling.

Coupon Rates, Yields, and Interest Rates are all different concepts, and a bond could have a Positive Coupon Rate and a Negative Yield, a Negative Coupon Rate and a Positive Yield, or any other combination of those.

A bond’s price “should equal” the present value of its future cash flows, and a bond’s Yield to Maturity “should equal” the IRR of the bond if held to maturity.

So, a bond’s price shoots up if market yields turn negative, but investors can also “bid up” bond prices, making yields negative or more negative in the process.

In countries like Germany and Switzerland, governments have issued zero-coupon bonds where investors bid up the prices, resulting in negative yields.

In effect, the low and negative interest rates have turned bond investing into a casino, where it’s more about quick flips for price appreciation than about earning modest interest income over time.
And the longer the maturity of the bond, the more sensitive it is to small changes in interest rates and market yields.

For example, the 100-year Austrian government bond issued in 2017 now trades at 200%+ of par value, and is up 70% this year, due to falling bond yields. Everyone is buying in because they think the bond’s price will keep skyrocketing.

What Are Central Banks Thinking?

Central banks seem to think that super-low and negative rates “spur consumption,” even though evidence in regions like Japan and Europe contradicts this.

Savings rates and overall economic growth have not changed, despite zero and negative rates – these rates have just encouraged people to chase yields in risky assets and to shift money around to different banks.

They’ve also allowed companies like Uber and WeWork to survive, when they wouldn’t be around with honest financial markets.

The Endgame

My prediction is that there will be a massive bond market correction and another European debt crisis, a currency or inflation crisis, or something similar.

A huge sell-off in the bond market, interest rates returning to normal, an economic recovery, higher inflation, or a sovereign debt crisis could all cause this.

Personally, I’ve allocated relatively little to equities, a lot to U.S. Treasuries, cash, and municipal bonds, and a fair amount to gold, and I’m staying away from all corporate bonds and non-U.S. government bonds.

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