The Dots, the Dollar and the Next Victim of Low Interest Rates

Posted On Mar 17, 2016 By Dave Gonigam

  • Fed post-mortem: The circular lunacy of “the dots”
  • Who suffers from lower-for-longer interest rates
  • Since when did insurance companies become too big to fail?
  • The end of crude’s long, cold winter, now in sight
  • Mocking government waste, Aussie-style (koalas are involved)
  • Still more reader dispatches from the war on cash’s front lines

Inflation is ticking up… but not enough for the Federal Reserve, it seems.

That’s the takeaway from the no-drama Fed announcement yesterday. Since it was a foregone conclusion the fed funds rate would be untouched, traders turned their attention to “the dots” — the projections of Fed governors and regional Fed presidents about future rate increases.

Sounds kinda, well, circular, right? A bunch of Fed pooh-bahs guessing what their fellow pooh-bahs will do with interest rates the rest of the year and beyond. If you’re not familiar with “the dots,” you might suspect we’re pulling your leg.

But no. Every three months, everyone’s guesses are put on a “dot plot” chart and posted in a PDF on the Fed’s website. Here’s yesterday’s….

What, they didn’t release their NCAA brackets at the same time?

Don’t sweat the details. Trust us, they don’t matter. What does matter is that three months ago, the Fed pooh-bahs expected four increases of a quarter-percentage point each during 2016. Now, only two.

Never mind the accelerating measures of inflation the last couple of months — which we’ve chronicled in these virtual pages. Janet Yellen & co. aren’t convinced it’s for real, not yet anyway.

“The dots” have sent the dollar tumbling… and everything denominated in dollars soaring.

The dollar index has been knocked below 95 for the first time this year. Meanwhile, S&P 500 sits at 2,031 as we write — a solid 15 points higher than at this time 24 hours ago. Treasuries have rallied, sending yields down; the 10-year note was a hair under 2% yesterday, but 1.9% now.

The biggest rallies, however, have come in oil and gold. Gold has zoomed up more than $30, the bid at last check $1,264. And crude is barely a quarter away from the $40 mark, territory last seen in December. (More about crude below.)

 There’s a major downside to interest rates staying “lower for longer”… and it’s not just the continued punishment of small savers.

We alluded to one of those consequences a few days ago: Pension funds aren’t getting the yields they’ve come to expect from their bond investments. The managers of state and local government pensions count on returns of 7–8% a year. Good luck with that when a major portion of your investments are yielding, well, less than 7–8% a year.

That’s what drove many pension managers to dabble in “alternative investments” like hedge funds and private equity in recent years. Not that that worked out very well, either — many pensions are now bailing from those positions.

And then there’s the hit insurance companies are taking. “Life insurers’ assets are being hit with the double-whammy of low yields and high credit losses at the same time,” says Jim Rickards.

“In essence, insurance companies are shadow banks,” he explains.

“Real banks take deposits and make loans or invest in government securities. Insurance companies underwrite promises to policyholders and also invest in government securities and other assets to provide the returns to fulfill those promises.”

Insurers don’t make their money from collecting premiums. They make their money investing those premiums — “the float,” as it’s known. “In effect,” says Jim, “insurance companies take in premiums and invest them, mostly in bonds, to earn enough to pay off their promises to policyholders. Then they keep any excess investment returns.”

The arrangement has worked well for a long time. “Insurance companies worry about the mismatch between loss assumptions and investment returns,” Jim goes on. “Insurers use statistical methods and actuarial assumptions to estimate when and how much they will have to pay in claims. Then they construct their investment portfolios to match those estimated liabilities.

“Since policy claims are based on human lives or catastrophic risks that take years materialize, long-term bonds are a good asset class with which to offset any liability for claims.

“But what happens when the assumptions about risk and return are badly distorted?” Jim asks.

“What happens when policyholders are promised 6% or 7% embedded returns on their life insurance but bonds yield only 2% or 3%? This is the world turned upside down. This is the crisis facing the insurance industry today.

“If interest rates go lower, insurers will have some added gains on their bonds but they’ll suffer underwriting losses because they have promised much higher returns to their policyholders. On the other hand, if interest rates rise, it will make it easier to pay off the policies, but the portfolio losses will be horrendous.

“This is the kind of Roach Motel trap the Federal Reserve has created for investors by manipulating long-term interest rates with quantitative easing, zero interest rate policy and now even talk of negative interest rates.”

Here’s another wrinkle: The government has deemed three of the big insurers as too big to fail.

The formal term is “systemically important financial institutions,” or SIFIs. It’s a designation that came into force with the Dodd-Frank Act that was passed to — ahem, theoretically — prevent another Panic of 2008.

The Big Four commercial banks — Bank of America, Citi, Chase, Wells Fargo — are all on the SIFI list. So are Goldman Sachs and Morgan Stanley. Plus several foreign banks with major U.S. operations.

And so are three big insurers — AIG, MetLife and Prudential. For all intents and purposes, they’re being regulated like banks now.

“In the years ahead,” says Jim, “the Fed intends to force the SIFIs to buy government bonds as part of a plan to monetize the U.S. government debt.”

For months now, Jim’s been telling us about bipartisan plans to ramp up federal spending in hopes of juicing the economy; the budget-busting deal President Obama cut with House Speaker Paul Ryan last December is a preview of coming attractions.

“Basically, the government runs larger deficits and then covers the deficits with more Treasury debt,” he explains. “The Fed prints the money to buy the new debt and forces the SIFIs to help them prop up the bond market.”

It’s coming at a bad time for the insurers: “Another aspect of SIFI status,” says Jim, “is that your stock starts to trade more like a bank than an insurance company. The bank sector is one of the worst performing sectors of the stock market this year. The bank stock carnage is just beginning as the full weight of credit losses from the energy, mining and manufacturing industries starts to hit home.”

[Ed. note: As if that’s not enough to worry about, Jim’s been hearing disturbing rumblings from the Pacific Rim. One of his high-level contacts says a rogue group of individuals is about to unleash the financial equivalent of an A-bomb on Japan.

“This will not be a ‘great currency shock’ or devaluation,” he clarifies. “It won’t be an unexpected stock market crash. And it won’t be a sovereign debt default or corporate bankruptcy.

“Instead, it may destroy one of the largest and most important financial markets in history. A $1.5 quadrillion market, with connections to every country, company and individual investor on the planet.”

Jim’s headed to Tokyo tomorrow to gather more details in person. Then next Tuesday night at 7:30 p.m. EDT, he’ll lead a live online briefing from Tokyo to help you prepare. It won’t cost you a thing to look in on this event. Click here now to reserve your spot.]

“Crude looks like it’s carving out a higher low,” says Greg Guenthner of our trading desk.

“Crude gained nearly 6% when all was said and done on Wednesday. That’s a pretty big one-day rip for black gold, especially when you consider how sluggish oil has been this week.”

Description: The End of the Oil Rout

Even the energy stocks are looking attractive. “While the S&P 500 is down about 1% year to date,” says Greg, “the Energy Select Sector SPDR (NYSE:XLE) is actually up nearly 4%.

“If this new oil ‘floor’ is the real deal, we could see these beaten-down energy names take on a bigger leadership role in the markets. Pipeline stocks were up big yesterday. So were refiners. Even independent oil and gas names were getting jiggy with higher prices.

“Will this move mark the long-term end of the oil rout? I’m not sure. But it does set us up for higher prices in the days ahead.”

This government is obsessed with hugging koalas,” says an outraged member of Australia’s opposition Labor Party.

The party has taken a cue from American politicians and published a Waste-pedia booklet, accompanied by a Waste Watch website.

The Australian edition, however, has a special focus on “koala and other marsupial-related events.”

“We’ve had $400,000,” opposition minister Pat Conroy says, “which included [foreign minister] Julie Bishop paying $133,000 to fly four koalas to Singapore Zoo.”

Description: JulieBishopTweet.png

“She spent I think it was $130,000 taking diplomats to Western Australia,” adds Conroy, “where they hugged wombats for a change — so at least they changed up the marsupial.”

The party says it had to resort to Freedom of Information requests to glean the details of this marsupial malfeasance.

Seriously? Koala diplomacy as a black-budget item? That’s an obsession with secrecy…

“You think requiring a driver’s license at Chase to deposit $1,000 is bad?!” reads the first of several reactions to yesterday’s war on cash episode.

“I was required to show Chase my license for a $100 cash deposit. When I asked why, she replied it was for my own protection. BS!”

“I went into my Midtown Manhattan Chase branch few weeks ago,” writes another reader, “and asked to exchange 10 $20 bills from their ATM into two $100 bills.

“They refused to do it unless I gave them my account number so they could note the transaction in their records. The reason they gave me was that ‘bank management’ wanted to know the ID of everyone depositing or withdrawing cash.

“The fact I was doing neither did not alter their position.”

“A friend went to the new Amazon bookstore in Seattle this weekend,” a reader writes.

“She tried to buy a magazine and pay cash — nope, don’t take cash. OK, debit card — nope don’t take debit card. You must use your Amazon account.

“Apparently, legal tender is no longer acceptable to purchase items.”

“For years, I have not spent my change,” writes another. “In the beginning, I would take accumulations to the bank that held my mortgage and make a payment on the principal.

“That mortgage has long been paid off, but I still accumulate change — force of habit, I guess — and periodically swap accumulations for a ‘brick’ of dollar clad coins.

“The last year or so as I have read the increasing number of articles about the war on cash, the thought occurred to me that in the absence of paper, clad coins could be useful in mundane transactions. Your thoughts?”

The 5: Assuming the clerk at the convenience store knows how to open the cash register when the power’s out and the card readers aren’t working… how likely is it they’re going to recognize a dollar coin with Sacagawea or Susan B. Anthony or Millard Fillmore on it?

Heck, the presidential dollar series was so unpopular the program was suspended in 2011. To the best of our knowledge, hundreds of millions of them are still warehoused at a Fed facility somewhere here in Baltimore.

The Mint planned to issue four coins a year honoring each president in chronological order. They only got up to James Garfield, who served in the 1880s. (A handful continue to be produced for collectors. They’re finally up to Reagan now.)

“I was thinking about the war on cash and realized I have already complied,” writes our final correspondent.

“While I understand and value the need for cash, I hardly ever use it. I use my credit card for 99% of my transactions. I find it annoying and an inconvenience when I can’t use it.

“Then I started thinking why I do this and I realized the problem. I use a credit card because of the cash back. I rack up a nice amount of cash every year from this benefit. I make sure to shop for the best cash-back program and take advantage of all incentives.

“It is basically my savings account. You get 0% at the bank, but I can get an average of 1.5–2% on my expenses. I figure I am making these expenses anyway, so I might as well get something back for it.

“I try to use my cards responsibly. I pay the balance at the end of the month, and I am careful not to overspend. I am sure many out there forget about that part. In the meantime, I put just about everything I can on my card to maximize my rewards.

“The system rewards you for spending, not saving. It is the new normal until the whole thing comes to a halt.”

The 5: And so it goes…

Happy St. Patrick’s Day,

Dave Gonigam
The 5 Min. Forecast

P.S. Jim Rickards is still piecing together the details of this “financial A-bomb” targeting Japan that we mentioned earlier.

But from what he knows right now, every one of us stands to be affected. He figures stocks could gap down in a 10% flash crash within seconds… triggering the shutdown of stock markets, a freeze in commercial lending and the bankruptcy of major financial institutions.

Jim heads to Tokyo tomorrow to investigate further. But based on what he’s already found out, he’s decided to hold an exclusive online briefing this coming Tuesday at 7:30 p.m. EDT.

Participation is absolutely free. But we do have a limited number of spots available. Secure yours right now at this link.


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