Companies Get Paid to Be Junk in Europe
Henkel/Sanofi: the positives of negatives Somebody has to spend the money eventually
The developed market central banks are therefore reacting to market conditions by lowering their short term policy interest rates.* Given ongoing deficient investment spending, weak nominal and real GDP growth, an ongoing output gap due to excess capacity, and a lack of firm pricing power (inflation), it's logical for market participants to continue to anticipate that future economic activity will remain weak. This forces central banks to remain on hold as they have little choice but to respond to such market conditions.
Before developed market economies can escape the zero lower bound, the public and private sector must either issue a greater volume of financial securities to fund investment spending or market participants must slow their desire to accumulate such assets. * In an ideal world, firms and governments would be willing to utilize today's financial conditions by increasingly issuing financial securities to fund a far greater volume of productive investment spending. This in turn works to boost nominal and real GDP. In doing so, the output gap would diminish as the surplus labor and resources in the economy are more fully utilized. The current spare capacity in the developed world is therefore indicative of the private sector's inability to fully employ all resources available to it. Thus, low and falling interest rates are symptomatic of either risk aversion, redundant capacity, and/or a lack of new viable large scale investment opportunities.
If the private sector is continuously unable to fully satiate this excess demand for financial securities, it becomes very problematic when developed market governments are unwilling to do so as well. Not only does this needlessly leave available labor and resources underutilized, but it causes market participants to have little option but to bid up the price of the existing stock of financial assets to an exorbitant degree. This risks creating overvaluations that may need to be unwound in the future which only makes prevailing conditions that much worse and unpredictable. At the very least, rising valuations carry with them lower expected future returns to accompany today's low yield environment.
In a more tenable and reasonable political landscape, development market governments would issue highly sought after safe government bonds to fund either increased productive social and investment spending or cut taxes on those with the highest marginal propensity to spend on investment or consumption. If the private sector reacts by saving (accumulating) government transfers or using them to delever, both of which augment private sector net worth, this enables the government to continue such an operation until the spare capacity in the economy is fully mobilized. The latter, not financial ratios (debt/GDP), is only limiting factor when it comes to either public or private spending. Again the presence of low and falling interest rates on government bonds should serve as an indication that the private sector is willing to fund a larger government budget deficit that would correspond with an increase in the private sector's net worth. The necessity of this degree of government involvement would dissipate as soon as the private sector was able to once again carry economic activity forward.*
When the nominal GDP growth rate shows signs of improvement where the output gap closes, market participants should begin to anticipate higher corporate and bank earnings, improved financial valuations, a return to full employment, rising household incomes, improved private sector credit worthiness, a greater demand for credit, and a return of price pressures etc. This all carries with it the expectation that the prospective returns of privately created financial securities relative to safe government securities have increased on a risk adjusted basis. As market participants rebalance their portfolios away from government securities towards privately created financial assets and/or in the purchase of real assets for investment purposes, government bond yields should rise while private credit spreads narrow. Rebounding inflation expectations result from the anticipated return of firm pricing power, wage growth, and levitating commodities prices. All of the above enables central banks to then respond by tightening policy.
Without material improvements in those aforementioned trends, monetary tightening may prove to be unsustainable, As soon as risk adverse market participants begin to fear that tightening monetary and financial conditions will cause NGDP to slow too rapidly and act by bidding up safe government securities (de-risk portfolios), the central bank will be forced to cut policy rates once again Simply put, a central bank cannot sustainably tighten monetary policy until the prevailing economic conditions allow them to do so.
Thus, it becomes imperative for private and public sector behaviors to adjust course first beforehand*. Until that occurs, our low interest rate world will persist for the foreseeable future. Problematically, the expectation that the economic malaise is likely to continue is self-reinforcing given that present and planned behaviors are dictated by our thoughts about the future. Planned private investment is a function of future profitability on new projects, planned household consumption spending is a function of future expected income growth and job opportunities, and importantly lending is a function of both. What then is required is a strong commitment to collective action (fiscal monetary cooperation toward the maintenance of a predictable NGDP level path) that seeks to permanently change our views about the future.
*See the following from:
Helicopter Money: Or How I Stopped Worrying and Love Fiscal-Monetary Cooperation (emphasis added)
"Yields plunged. Corporate-bond sales ballooned. Values became utterly distorted.
Investors are now literally paying European companies to borrow. Sanofi, a French drugmaker, just became the first nonfinancial private company to issue debt that yields less than zero, according to Bloomberg News. Henkel, a German household products maker, quickly followed suit."
"European central bankers don't seem too worried about these distortions. In fact, they seem eager to see those animal spirits return to generate growth. The ECB is considering expanding its program, possibly to new asset classes.
The ECB may end up getting too much of what it wants. The Bank of America strategists warn against a rapid rise in leverage"
"In the meantime, European central bankers seem to have created an Alice-in-Wonderland credit market that's infecting the rest of the world. It's sending investors into emerging markets and the U.S., where corporate-bond yields are about the highest ever relative to similarly rated European debt."
Henkel/Sanofi: the positives of negatives Somebody has to spend the money eventually
"The point of the ECB buying corporate debt is to encourage greater issuance, the money so raised being deployed in ways that boosts economic demand. Superficially, this happy chain of events is hard to see here. Companies so financially strong do not alter their strategy when finance becomes a few basis points cheaper. But if the ECB’s open wallet has encouraged Henkel or Sanofi to greater issuance, they are now left with a problem similar to the one investors in the notes were trying to solve: what to do with this negative-yielding cash. Either they will find worthwhile investments — Henkel had an acquisition bid rebuffed last year — or the extra cash will ultimately return to investors. Some will be saved again, restarting the cycle, but some might be spent.
Negative yields send a gloomy signal: look how stagnant the economy is. But they also show the urgency with which investors send cash chasing around the economy, passed from those who cannot use it to those who just might."The relentless desire to accumulate financial assets is a consequence of income flowing to those with a low marginal propensity (asset managers acting as their intermediaries) to spend who then are attempting to recycle this purchasing power via the capital markets to those with a higher marginal propensity to spend. The presence of low, zero, and negative yields results from the excess demand for financial assets by market participants relative to the supply issued by both the private and public sector. Since the private and public sector are unwilling to fully accommodate this demand for financial securities, asset prices are bid up as bond yields fall.
The developed market central banks are therefore reacting to market conditions by lowering their short term policy interest rates.* Given ongoing deficient investment spending, weak nominal and real GDP growth, an ongoing output gap due to excess capacity, and a lack of firm pricing power (inflation), it's logical for market participants to continue to anticipate that future economic activity will remain weak. This forces central banks to remain on hold as they have little choice but to respond to such market conditions.
Before developed market economies can escape the zero lower bound, the public and private sector must either issue a greater volume of financial securities to fund investment spending or market participants must slow their desire to accumulate such assets. * In an ideal world, firms and governments would be willing to utilize today's financial conditions by increasingly issuing financial securities to fund a far greater volume of productive investment spending. This in turn works to boost nominal and real GDP. In doing so, the output gap would diminish as the surplus labor and resources in the economy are more fully utilized. The current spare capacity in the developed world is therefore indicative of the private sector's inability to fully employ all resources available to it. Thus, low and falling interest rates are symptomatic of either risk aversion, redundant capacity, and/or a lack of new viable large scale investment opportunities.
If the private sector is continuously unable to fully satiate this excess demand for financial securities, it becomes very problematic when developed market governments are unwilling to do so as well. Not only does this needlessly leave available labor and resources underutilized, but it causes market participants to have little option but to bid up the price of the existing stock of financial assets to an exorbitant degree. This risks creating overvaluations that may need to be unwound in the future which only makes prevailing conditions that much worse and unpredictable. At the very least, rising valuations carry with them lower expected future returns to accompany today's low yield environment.
In a more tenable and reasonable political landscape, development market governments would issue highly sought after safe government bonds to fund either increased productive social and investment spending or cut taxes on those with the highest marginal propensity to spend on investment or consumption. If the private sector reacts by saving (accumulating) government transfers or using them to delever, both of which augment private sector net worth, this enables the government to continue such an operation until the spare capacity in the economy is fully mobilized. The latter, not financial ratios (debt/GDP), is only limiting factor when it comes to either public or private spending. Again the presence of low and falling interest rates on government bonds should serve as an indication that the private sector is willing to fund a larger government budget deficit that would correspond with an increase in the private sector's net worth. The necessity of this degree of government involvement would dissipate as soon as the private sector was able to once again carry economic activity forward.*
When the nominal GDP growth rate shows signs of improvement where the output gap closes, market participants should begin to anticipate higher corporate and bank earnings, improved financial valuations, a return to full employment, rising household incomes, improved private sector credit worthiness, a greater demand for credit, and a return of price pressures etc. This all carries with it the expectation that the prospective returns of privately created financial securities relative to safe government securities have increased on a risk adjusted basis. As market participants rebalance their portfolios away from government securities towards privately created financial assets and/or in the purchase of real assets for investment purposes, government bond yields should rise while private credit spreads narrow. Rebounding inflation expectations result from the anticipated return of firm pricing power, wage growth, and levitating commodities prices. All of the above enables central banks to then respond by tightening policy.
Without material improvements in those aforementioned trends, monetary tightening may prove to be unsustainable, As soon as risk adverse market participants begin to fear that tightening monetary and financial conditions will cause NGDP to slow too rapidly and act by bidding up safe government securities (de-risk portfolios), the central bank will be forced to cut policy rates once again Simply put, a central bank cannot sustainably tighten monetary policy until the prevailing economic conditions allow them to do so.
Thus, it becomes imperative for private and public sector behaviors to adjust course first beforehand*. Until that occurs, our low interest rate world will persist for the foreseeable future. Problematically, the expectation that the economic malaise is likely to continue is self-reinforcing given that present and planned behaviors are dictated by our thoughts about the future. Planned private investment is a function of future profitability on new projects, planned household consumption spending is a function of future expected income growth and job opportunities, and importantly lending is a function of both. What then is required is a strong commitment to collective action (fiscal monetary cooperation toward the maintenance of a predictable NGDP level path) that seeks to permanently change our views about the future.
*See the following from:
Helicopter Money: Or How I Stopped Worrying and Love Fiscal-Monetary Cooperation (emphasis added)
As a reminder, during private deleveraging cycles monetary policy (even if radical) is unlikely to work if it is aimed at stimulating private credit demand. What matters is not monetary stimulus per se, but whether monetary stimulus is paired with fiscal stimulus and whether monetary policy is communicated in a way that helps the fiscal authority maintain stimulus for as long as deleveraging continues!
We do not plot the U.K.’s funding for lending scheme. While it is an example of fiscal-monetary cooperation, it is one that is aiming at the wrong goal. It assumes (like unconventional and radical forms of QE) that the private sector is not deleveraging, and that it is a lack of lending, as opposed to a lack of private demand for credit that is the problem. If it is the latter, the scheme won’t help and it will prove to be a fiscal-monetary cooperation of the wrong kind – one that aims to help private as opposed to public borrowing.
1978 – 2008, which is characterized by fiscal passivism and monetary “supremacy” marks the third epoch. This can be placed on the yellow quadrant of the map. The migration from the pink to the yellow quadrant played out during the Chairmanship of Paul Volcker and against the backdrop of the Sargent-Wallace (1981) framework. Its hallmarks were the supremacy of monetary policy and a much diminished, second fiddle role for fiscal policy (see Blanchard, et al, 2010).
The orthodox policies of balanced budgets, tight money and fixed exchange rates against the backdrop of a deleveraging private sector drove the economy into a cycle of debt deflation (Fisher, 1933).
The lesson here is that central bank independence is not a static state of being. Rather, it is dynamic and highly circumstance dependent: during times of war, deflation and private deleveraging, fiscal policy will inevitably grow to dominate monetary policy and during times of peace, private leveraging and inflation, monetary policy will inevitably grow to dominate fiscal policy.
This is the secular life cycle of fiscal-monetary relations that goes hand-in-hand with secular private debt cycles.
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