Doug Kass shares his views every day on RealMoneyPro. Click here for a real-time look at his insights and musings.
Why Lower Rates Aren't Helping the U.S. Economy
As this chart from The Daily Shot shows, 10-year Treasury yields touched 1.35% this week -- the lowest nominal yield in U.S. history:
Source: Atlas and Global Financial Data via The Daily Shot
But despite such low rates, the Federal Reserve has arguably lost its potency, effectiveness and ability to catalyze U.S. economic growth.
Indeed, it's well known that Friday's historically low rates have:
- Disadvantaged savers.
- Hobbled banks and insurance companies (and pressured their profits).
- Delayed fixed business-investment plans (despite setting the time value of money at zero).
Of course, some people will argue that lower interest rates are a boon to our economy in other ways. For example, most observers generally accept the idea that lower interest rates buoy the mortgage industry.
But this argument falls down when you look closely at what banks are actually doing. For instance, the dramatic drop in Treasury yields that we've seen over the past six months isn't meaningfully helping home buyers in the way that many have previously assumed. That's because it hasn't translated into significantly lower mortgage rates.
Let me give you a personal example:
I considered refinancing my mortgage with JPMorgan in early 2016, but passed because I thought mortgage rates could move lower. At the time, JPM was offering me a 3.25% fixed-rate 15-year mortgage on a home with an estimated market value of about 7 times the mortgage amount.
Fast forward several months and JPM's mortgage rates haven't changed at all. Even though Treasury yields have dropped by about 70 basis points, the bank is still offering 15-year mortgages at 3.25% and 30-year ones at 3.75% -- exactly the same levels available earlier this year.
It's the same story at other money-center banks that I queried. All have failed to drop their mortgage rates commensurate with the steep decline in Treasury yields.
The Bottom Line: Mortgage borrowers simply haven't benefited from Treasury rates' latest leg lower.
It appears that JPMorgan and other banks are reluctant to make fixed-rate mortgages at rates that reflect Treasury yields' recent drop.
Consequently, I'm selling out of the position after about 10 days for a small loss. At the same time, I'm adding to my short of the iShares 20+ Year Treasury Bond ETF (TLT) , which is on my "Best Short Ideas" list.
I'll have more to say about my strong conviction to short bonds.
That said, we as investors and traders must always consider risk vs. reward by asking ourselves a fundamental question: "What's the upside and downside to each and every one of my decisions?"
When I ponder that question these days, I find that I remain fearful of the markets and see an unfavorable risk-vs.-reward quotient.
I recently referred to the Brexit as "The Big Chill" (click here and here), concluding that a number of headwinds would grow out of it -- especially contagion risk. I believe that these headwinds will underscore the global economic recovery's fragility, along with central bankers' impotence and the deleterious impact on negative interest rates. Add it all up and I expect a less-favorable and potentially unfriendly valuation backdrop.
Let's look at why:
The World Is Flat and Interconnected
Since Wall Street hit its "Generation Low" in March 2009, investors have literally scoffed at untoward events -- whether political, economic, terrorism-oriented or anything else.
But I believe that while the bulls see the Brexit vote as a non-event, they're likely wrong. Instead, I expect that we're already beginning to feel the effects of a slow reversal in the globalization that's long been prominent in our flat and interconnected world.
The dominoes have already begun to fall. For instance:
- The British Pound Is Collapsing. "Cable" is under 130 this morning, which could exacerbate global deflation.
- U.K. Property Values Will Likely Drop. Buoyed by high-paying finance jobs that might now be exported, U.K. property values will probably be in retreat. (Click here to see my colleague Antonia Oprita's analysis of that.) But unlike what happens in America, real-estate collateral is at the heart of many large and small British companies' trade and project finance.
- Liquidity Pressures Are Rising. As Oprita noted in her column, several U.K. property funds have imposed trading gates on redemptions. That's eerily reminiscent of 2007, when several mortgage funds halted redemptions. They ultimately failed anyway, heralding in the Great Recession.
- The EU Banking Crisis Takes Center Stage. I believe that the European banking crisis (which I highlighted in Is Deutsche Bank The Canary in the Coal Mine?) will now be in full bloom. For instance, markets ignored the Italian banking crisis for months, but it's likely to take center stage now. The problem will also probably spread to other peripheral European Union countries' banks, which are generally mismanaged, leveraged and befuddled by massive amounts of nonperforming loans. This could ultimately destabilize European politics and spark a trend of more economic populism and less globalization.
- America Will Not Be an 'Oasis of Prosperity.' No country is an island in today's interconnected world. We won't be unaffected by the chaos that I expect to occur outside of our borders.
As I've previously discussed, 2016's major economic themes prior to the Brexit vote included an economic ebbing, increased concerns that zero and negative interest rates were destructive and a growing fear that central-bank intervention was becoming impotent.
But now, all of these trends seem destined to worsen in the Brexit referendum's aftermath. The ensuing flight to safety might lead to lower global interest rates, but might not inflate price-to-earnings multiples (as bulls like my pals Tom Lee and Tony Dwyer are arguing).
Indeed, zero and negative rates could have the opposite effect by further retarding a capital-spending recovery while leading to less consumption and more cash hoarding by the savings class. (This is the so-called "Paradox of Thrift.")
I'll talk a little later this morning about what I expect this will mean for markets.