I wanted to look at the effect a negatively shaped yield curve (where 30yr gov't bonds yield less than 2yr gov't bonds) or where the entire yield curve is in negative rates, has on commercial/investment banks.
Given rates are largely moving to a negative posture in Europe it makes sense to look at the situation there, but keep in mind, it is moving that way in North America too so have some foresight on what is happening there to protect yourself from it happening here.
First of all, let's look at the Swiss Gov't bond curve where 30yr bonds just went to negative yields this morning! That's right, you are paying the Swiss National Bank about .03% to hold on to your money for 30yrs. Why? A couple of main reasons: 1) safety of principal and 2) the threat of deflation. (Top line is the Swiss curve just before the 2008 crisis and the bottom is today).
Now lets look at the largest Commercial/Investment bank in Europe...Deutsche Bank. Deutsche Bank (DBK) tries to make money in many different ways but Capital Markets activity and Lending are probably the two key ones. Well Capital Markets (trading/sales revenues, structured products like CLO's etc) have come off substantially. As for lending, well it has now been turned on its head. Two reasons negative rates and inverted yield curves suck for banks: 1) they typically borrow from the central bank on an overnight basis and invest out the curve but when the curve is inverted, they can't put that trade on and 2) when rates go negative, how do they borrow and lend with the same Net Interest Margin...it gets squeezed hard.
So here is the result. See DBK's 5yr CDS (Credit Default Swaps) as a metric for what credit markets think about DBK. The higher the CDS Spread is, the worst the view on DBK and the higher the potential for a Credit Event...(read, Default). Moving higher...
And here is a DBK stock chart. Note that CDS and the Common Equity of DBK will move in the opposite direction but CDS (remember how Scott says every week that Bonds (and Credit, like CDS) lead all financial markets?) has a slight advance lead on the trend.
So, can this happen to US and Canadian Banks? Caveat Emptor because the bond markets in North America are moving rather quickly to the same level and shape of bond curves across the globe.
Another reason why High Rock accounts do not own any bank securities.
Next up on this Mini-Series on Banks and Yield Curve will be the Debunking of the Myth that Canadian Banks are "safe and steady".