Can’t say we didn’t warn you. Negative rates are killing fixed income. In Europe, it might even be killing banks. Amazing as it may seem, free money is not keeping the over-leveraged banks of Europe fundamentally sound. Some may be facing their own Lehman Brothers moment.
No one wants to harken back to the blowout days of Lehman and Bear Stearns in 2008, but while U.S. financials may be selling off because investors think they’re over valued; European financials are selling off because periphery banks are in trouble. Deutsche Bank might be too. The stock is down 37.4% so far this year.
“It was not long ago when the banking sector was the primary element which kept traders fearful and now the same distress is back on the street of Europe but with a different look,” says Naeem Aslam, chief market strategist for AvaTrade International in Edinburgh. “Investors are anxious about European banks recovering on their own. The negative rates introduced by the European Central Bank have thwarted that expectation. Given that the bank of Japan is following the footsteps of the European Central Bank and has introduced negative rates too, the same fear is hunting their markets. The markets got hit by a strong virus and the vaccination of negative rates, which did spur some risk appetite, has become immune. This could prompt an immensely horrifying sell off for the global markets because the underlying factor is that the central banks have failed,” Aslam says.
Financial firms in northern Europe told FORBES on background that there is a chance some Spanish or Italian banks may fall into receivership. Here’s the problem for European fund managers and investment banks. Their clients, be they rich individuals, life insurance or pension funds, can’t keep money in savings accounts because of negative rates. They can’t go to bonds because of negative yield. If they invested in equities this year, they are down worldwide. The same holds for Japan. Most are afraid of taking on the currency risk in emerging markets, believing the dollar will remain strong for the time being. They have no where to hide. That’s the mindset.
Italian and Greek banks are still fragile. The National Bank of Greece is down 94% this year. In just six weeks, this stock has lost almost all of its market value. UniCred, the holding company behind UniCred Capitalia, Italy’s largest bank, is down 43.5%.
Italy might be the next Greece. Investors are looking at that now, and selling. The lack of reforms there coupled with negative deposit rates have put more pressure on all European banks which were pressured to lend more and invest in stocks, now losing value.
While Europe may not have one major brand name investment bank fold this year, a series of mid-cap and even one or two large cap bank closures in southern Europe will be enough of a hit to compare it in size to the shock-and-awe that followed the bankruptcy of Lehman and Bear.
In late December, the Portuguese central bank bailed out Novo Banco — which is interesting enough because this is the bank that was created out of the ashes of Banco Espirito Santo (BES). They used to be a big broker-dealer in Brazil. Now they’re gone.
Zero Hedge pointed this out today on their website: $7 trillion in bonds pay no interest. This is the death of the fixed income market in the heart of Europe.
Negative Rates In Question
Last week, famed short seller Marc Faber practically had a panic attack on CNBC Europe when he questioned why investors were willing to give central bankers so much power. He said negative rates were terrible for European financials.
“We have been on the short side of European financials now since January,” says Tadasi Tsukagusi, a hedge fund manager in Tokyo who runs the $35 million Disaster Protection Fund. Coming from Japan, he knows a thing or two about negative interest rates and inflation. “We’re short the DAX, the CAC, STOXX50, all European Equity Index Futures. The ECB has limited influence now to increase inflation. Deflation is going to to wallop European markets.”
The likelihood that Mario Draghi and the European Central Bank will delve even lower into negative rate territory next month creates a further drag for financials. Negative interest rate policies (NIRP) represent a tax on banking which is reducing the profitability of banks in cases where those costs are not being passed on to consumers, which could easily become counterproductive, Vladimir Signorelli, founder of Bretton Woods Research told clients in a note on Tuesday.
NIRP is the financial market’s zica virus.
In Switzerland, the Swiss National Bank (SNB) is pursuing NIRP despite being a non-ECB entity. The banks there are beginning to increase mortgage rates in order to offset the cost of negative deposit rates held with the SNB. On Friday, HSBC prepared the ground for imposing negative rates on business depositors by sending a notice to customers that they could be assessed negative interest on their deposits citing ECB policy and its associated costs.
The headwinds are impacting more than just investment and money center banks. German life insurers — an industry with more than 90 billion euros of annual premium income to pay out and close to $1 trillion in assets under management — are facing an existential crisis. Payout yields continue to outstrip returns in sovereign bonds. A Bundesbank stress test in 2015 found that a third of the sector would be ultimately short of capital in the kind of extreme interest rate scenario that is already emerging. The International Monetary Fund warned last year that the failure of one life insurer “could trigger an industry-wide loss of confidence”, that in turn “could engulf the financial system”.
The only element which is going up is the cost of insuring banks against their possibility of default.
Deutsche Bank continues to suffer heavy losses. Investors are raising questions if the bank’s operations are even solvent. The bank says its books are “rock solid”. Nevertheless, Western Europe’s most important bank is now worth less than it was at the height of the Great Recession. Easy money and negative rates have not made financials any more enticing in Europe.
The Lehman Brothers moment may be less of a big bang in Europe, and more of a slow, third degree, burn.