ultra low / negative interest rates in Germany

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ochotona
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Re: ultra low / negative interest rates in Germany

Post by ochotona » Thu Feb 11, 2016 9:42 pm

economicsjunkie wrote: Correct, the longer the duration the more volatile the bond. And?
The answer to your question is people will go to shorter duration in order to lower the volatility, because they may give up a tiny bit of coupon, but they avoid huge capital loss potential. You asked the question.
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Re: ultra low / negative interest rates in Germany

Post by dragoncar » Fri Feb 12, 2016 12:27 am

ochotona wrote:
economicsjunkie wrote: I've seen this suggestions here a couple of times now. If low/negative interest rates are of concern here, then why in the world would a switch to a shorter duration be sensible, where interest rates would be even lower/more negative?!
The issue is the risk of changes in the market price of the bond due to interest rate changes.

{picks up HP-12C Financial Calculator}

Let's say you buy a new 30 year Treasury for $10,000, and the coupon rate is 0.5%. The Present Value (PV) of that bond, if the market interest rate is 0.5% is just $10,000. You pay $10,000, you get your 0.5% interest for 30 years, and in 30 years you get your $10,000 back.

If the market interest rate increases to 1.0%, your PV of the bond just fell to $7548.26. You just had a -24.5% change because of a 0.5% change in the interest rate. Your bond has to sell at a discount in order for it to be attractively priced for someone to buy who might just as well buy a new 30 year bond paying 1%, not the old 0.5%.

That's what long bond investors are so freeking scared of.
So you rebalance into more bonds.  Then the rate drops .5%.  Where are you now?
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Re: ultra low / negative interest rates in Germany

Post by lordmetroid » Fri Feb 12, 2016 2:52 am

ochotona wrote:
economicsjunkie wrote: I've seen this suggestions here a couple of times now. If low/negative interest rates are of concern here, then why in the world would a switch to a shorter duration be sensible, where interest rates would be even lower/more negative?!
The issue is the risk of changes in the market price of the bond due to interest rate changes.

{picks up HP-12C Financial Calculator}

Let's say you buy a new 30 year Treasury for $10,000, and the coupon rate is 0.5%. The Present Value (PV) of that bond, if the market interest rate is 0.5% is just $10,000. You pay $10,000, you get your 0.5% interest for 30 years, and in 30 years you get your $10,000 back.

If the market interest rate increases to 1.0%, your PV of the bond just fell to $7548.26. You just had a -24.5% change because of a 0.5% change in the interest rate. Your bond has to sell at a discount in order for it to be attractively priced for someone to buy who might just as well buy a new 30 year bond paying 1%, not the old 0.5%.

That's what long bond investors are so freeking scared of.
You can argue the same principles for any of the four assets, it all depends on the current economic climate. There will always be one asset that is out of favor for some reason or the other.

With deflation looming on the horizon as the QE and debt bubble is about to pop, I actually look very favorably upon bonds, even with these low interest rates. Because a 0,5% yield will be a heck of a lot better than gold who will depreciate in value thanks to cash becoming more and more scarce and valuable. As well as stocks which may never recover for the next few decades alike Japan because the companies will have a hard time making the bottom line as they need to pay off their debt financed assets that bought at the top of the bubble and not generate any growth.
Last edited by lordmetroid on Fri Feb 12, 2016 2:56 am, edited 1 time in total.
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Re: ultra low / negative interest rates in Germany

Post by technovelist » Fri Feb 12, 2016 6:26 am

lordmetroid wrote:
With deflation looming on the horizon as the QE and debt bubble is about to pop, I actually look very favorably upon bonds, even with these low interest rates. Because a 0,5% yield will be a heck of a lot better than gold who will depreciate in value thanks to cash becoming more and more scarce and valuable. As well as stocks which may never recover for the next few decades alike Japan because the companies will have a hard time making the bottom line as they need to pay off their debt financed assets that bought at the top of the bubble and not generate any growth.
As Ben Bernanke noted some time ago (http://www.federalreserve.gov/boarddocs ... t.htm#fn18), central banks can prevent deflation in any country by printing money. Of course the eventual result of this policy will be the destruction of the currency, but they believe that they can stop in time to prevent that. In my opinion, people are starting to realize that printing money is exactly what the central banks are doing and will continue to do, which is why gold has started to move up recently.
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Re: ultra low / negative interest rates in Germany

Post by Lang » Fri Feb 12, 2016 6:33 am

So far central banks have had little luck with preventing deflation...
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Re: ultra low / negative interest rates in Germany

Post by technovelist » Fri Feb 12, 2016 6:40 am

Lang wrote: So far central banks have had little luck with preventing deflation...
Then they just aren't printing fast enough.

Anyway, the whole notion of being frightened by deflation is just political cover for inflation. Deflation is the result of inflation, and counteracts the distortions caused by the inflation so that the pattern of spending and investing is more in line with actual consumer preferences. To prevent this, central banks pile on more inflation, which merely prolongs and worsens the distortions.
Another nod to the most beautiful equation: e + 1 = 0
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Re: ultra low / negative interest rates in Germany

Post by BearBones » Fri Feb 12, 2016 1:40 pm

technovelist wrote: As Ben Bernanke noted some time ago (http://www.federalreserve.gov/boarddocs ... t.htm#fn18), central banks can prevent deflation in any country by printing money. Of course the eventual result of this policy will be the destruction of the currency, but they believe that they can stop in time to prevent that. In my opinion, people are starting to realize that printing money is exactly what the central banks are doing and will continue to do, which is why gold has started to move up recently.
My recollection from past threads is that central banks have a lot more control over inflation than deflation. "Printing money" does no good if there if the economy is stagnant (such as from fear, satiety, or the aging of a population) and the money does not go into circulation. And it does not necessarily result in inflation.

Do I remember correctly?
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Re: ultra low / negative interest rates in Germany

Post by economicsjunkie » Fri Feb 12, 2016 2:11 pm

ochotona wrote:
economicsjunkie wrote: Correct, the longer the duration the more volatile the bond. And?
The answer to your question is people will go to shorter duration in order to lower the volatility, because they may give up a tiny bit of coupon, but they avoid huge capital loss potential. You asked the question.
If I understand you correctly you're suggesting that the capital gains upwards are limited when rates are so low, so might as well go for a duration where the downside risk is reduced. Am I understanding you correctly?
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Re: ultra low / negative interest rates in Germany

Post by economicsjunkie » Fri Feb 12, 2016 2:16 pm

lordmetroid wrote: Because a 0,5% yield will be a heck of a lot better than gold who will depreciate in value thanks to cash becoming more and more scarce and valuable.
What historical evidence are you relying on when you say gold will depreciate during deflation? The Great Depression (granted, the gold price was fixed and changed by the government but so what), Great Recession (no price fixing), and Japanese deflation of the 90s off and on through now seem to contradict this theory.
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Re: ultra low / negative interest rates in Germany

Post by dualstow » Fri Feb 12, 2016 4:05 pm

Whether or not gold will depreciate, it is these low-yield times that make it easy for me to buy it. After all, the argument often goes that gold "just sits there." If my savings were earning 5%, I'd have to think hard about it, but right now my cash is just sitting there.
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ochotona
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Re: ultra low / negative interest rates in Germany

Post by ochotona » Fri Feb 12, 2016 5:53 pm

economicsjunkie wrote:
ochotona wrote:
economicsjunkie wrote: Correct, the longer the duration the more volatile the bond. And?
The answer to your question is people will go to shorter duration in order to lower the volatility, because they may give up a tiny bit of coupon, but they avoid huge capital loss potential. You asked the question.
If I understand you correctly you're suggesting that the capital gains upwards are limited when rates are so low, so might as well go for a duration where the downside risk is reduced. Am I understanding you correctly?
I can't speak for others, but for me, there seems to be an asymmetical risk to the downside when you get to tiny positive or negative coupon rates for long duration bonds. Unless you are prepared to sell out of your position very quickly, and you have specific targets for so doing, being long in long bonds as interest rates go negative can only end in tears.

It's like people who piled into stocks in May 2015... no difference. It's greed, and a willing disregard for downside risks.

But if your investment policy is to let the PP's allocation take care of those risks, then I can't really criticize. That's your personal choice. We all make differing calls.
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Re: ultra low / negative interest rates in Germany

Post by technovelist » Fri Feb 12, 2016 8:58 pm

dualstow wrote: Whether or not gold will depreciate, it is these low-yield times that make it easy for me to buy it. After all, the argument often goes that gold "just sits there." If my savings were earning 5%, I'd have to think hard about it, but right now my cash is just sitting there.
With savings "earning" negative rates, it's really hard to come up with an argument against gold, which pays a big fat 0% (before storage fees, but still...).
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