Central bank policy is proving increasingly ineffective, and now Europe and Japan have turned to negative rates. What's the impact on the US if the Fed must resort to similar measures?

1. RIP Central Banks
25 February 2016
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2. HiddenLevers War Room
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3. Market Update
RIP Central Banks
Scenario: Negative Rates?
RIP Central Banks
NEW

4. HiddenLevers
MARKET UPDATE

5. Market Update
sources: HiddenLevers, History.com, WSJ, Bloomberg
1
Oil
Production
Freeze
2
3
Boomers
Now Dying
Call to Break
Up TBTF Banks

6. Market Update: China Slowdown
4
sources: HiddenLevers, China Banking Regulatory Commission, People’s Bank of China, NY Times,
China
bad loans
now $645b
Jan 2016
Record Bank
Lending
Reducing
required
coverage
First World
markets
over China?
China markets plummeting. USA not reacting.
US subprime
crisis began
at $600b
Domestics
moving
money out

7. Fed Stress Tests: 2015/2016 Comparison
Fed Stress Test 2015:
• Adverse = Stagflation
• Severely Adverse = Crash
with flat inflation
Fed Stress Test 2016:
• Adverse = Deflation
• Severely Adverse = NIRP
sources: Federal Reserve 1, Federal Reserve 2
Lever 2015 Adverse 2015 Severely Adverse
3M Treasury 0.0 -> 2.6 0.0 -> 0.1
CPI 1.1 -> 4.0 1.1 -> 1.1
Dow Total Stock Market -20% -58%
Lever 2016 Adverse 2016 Severely Adverse
3M Treasury 0.1 -> 0.1 0.1 -> -0.5
CPI 0.2 -> -0.1 0.2 -> 1.3
Dow Total Stock Market -26% -51%

8. HiddenLevers
RIP CENTRAL BANKS

9. RIP: Interest Rates Worldwide
sources: WisdomTree, MW
Yield curve shows long
duration on low interest debt

10. RIP: Battle Against Deflation
sources: JP Morgan, Markit
Negative interest rates not lowering currency value
as hoped in Japan, Euro area.
25% of Developed
Gov’t debt has
negative interest rates.
($23tn universe)
Inflation
still ~0

11. RIP: Why Negative Rates?
sources: HiddenLevers, Whitehouse.gov, Financial Times
devalue currency
get people spending
robot takeover
commodities perfect storm
first world demographic shift
Using negative rates to fight deflation is like using plastic forks to fight an atom bomb
jumpstart growth

12. RIP: Impact on Borrowers + Savers
Effect on Savers
• Fees on deposits
• Switch to other stores of
value (gold, bitcoin, etc.)
• Insurance companies +
pension funds at risk
• Take on higher risks in
search for yield.
Effect on Borrowers
• Low borrowing costs for
companies/households
• Banks unwilling to lend
• Who would buy a -1%
corporate bond?
sources: Economist, NYTimes

13. Negative Rates: Impact on Banks
sources: Credit Suisse, HiddenLevers
Negative rates have
led to drop in bank
stocks in EU / Japan
BUT – the underlying
factor is interest rate
margin, not rate level

14. RIP: Global Bank Comparison
sources: HiddenLevers, Economist
2008-09
US banks recapitalized,
Europe not so much
Japan banks in 5y ditch
2015-16
US banks lending Europe
not recovering
Japan banks in 10y ditch
-38% Japan
-28% Europe
-16% USA

15. RIP: Fed Report Card (post-2008)
sources: HiddenLevers
US GDP - Meh
US Inflation - Fail

16. RIP: Central Banks Irrelevant in 2016
source: HiddenLevers, Fiscal Times, Telegraph, Economist
Japan
-0.10
ECB
-0.30
Switzerland
-0.75
Fed:
+0.50
Negative
rates not
working
abroad.
Central
banks
out of
ammo?
Denmark
-0.65
Sweden
-0.50

17. RIP: Central Banks Irrelevant in 2016
source: HiddenLevers, Fiscal Times, Telegraph, 2, Economist
Japan
-0.10
ECB
-0.30
Switzerland
-0.75
Fed:
+0.50
Negative
rates
abroad
Rate
hike in
USA
Surprise
results
Denmark
-0.65
Sweden
-0.50
yen euro
10y
Treasuries
unemployment
euro
peg
franc

18. HiddenLevers
NEW SCENARIO: NEGATIVE RATES?

19. GOOD: Reflation Continues
source: HiddenLevers,
CPI trending up in USA, despite Oil Crash
Rising Rents
+
Home Prices
CPI rising since
Jan 2015
Healthcare
Inflation UP

20. BAD: Financials Struggle
No rate hikes = no margin for big banks
source: HiddenLevers, Foreign Policy,
low
commodities
mitigate
pressure on
equities
persists
recession
avoided
-14%
-7%

21. UGLY: USA Joins Club
new all time
lows on 10y
treasuries
source: HiddenLevers
first world
demographics
to blame
Fed follows Japan + Europe into negative rates
mild recession
a la EU/Japan
savers likely go
to cash + gold
gold

22. Scenario: Negative Rates?
12M T-bills
-0.3%
S&P
-20%
12M T-bills
0.1%
S&P
-8%
12M T-bills
0.8%
Fed is able to raise rates as
inflation trends toward 2%
in the USA. This enables
financial sector margins to
recover.
Inflation below target forces
the Fed to cut rates.
Financial sector hit hard,
while market as a whole
nears a bear market
(measured from 2015 high)
USA joins EU + Japan in
negative rate territory, as
deflation pulls US into mild
recession.
Good:
Reflation
Continues
Bad:
Financials
Struggle
Ugly:
USA
Joins
Club
S&P
+8%

23. RIP Central Banks – Take Aways
NIRP hits financial sector hardest NIRP causes flight to safety
First World Deflation overwhelms
Monetary Policy
NIRP does NOT weaken currency