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Is Cash Hoarding Impacting Bond Market?

Potential for Higher Inflation
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EDITOR NOTE: When we, as individuals, suddenly shift to saving more than we spend, it’s typically viewed as a smart move--one that may indicate we’re currently experiencing a few financial bumps in the road. In contrast, when a bank opts to hoard cash at the expense of its customers, then such a move signals something much more serious ahead, and on a much wider scale. Banks are strong indicators of the economy--watch what they do, and you may be able to see what the investing public can’t. And right now, their movements suggest a potentially massive storm on the horizon.

There's a growing list of borrowers desperately holding on to cash.

Lloyds Banking Group Plc has joined Deutsche Bank AG and Aareal Bank AG in going against normal protocol in order to hoard cash. The British bank has become the third European bank this year to refuse to redeem an outstanding "CoCo" bond at its first call date, something that was unthinkable a few months ago. CoCo (Contingent Convertible) bonds, also called AT1s (Additional Tier 1 regulatory capital) are very risky because the investor can lose everything if the borrower fails. This is why CoCos pay a juicy interest rate and why, up until now, there has been an understanding that investors will be able to redeem the bonds at their first call date.

By refusing to redeem, Lloyds retains the cash which it says it needs to deal with "extraordinary market challenges presented by Covid-19." That's code for "we need to retain all the cash we can because we're frightened about the future," which is the quintessential psychology of deflation.

As the chart shows, credit spreads have recovered along with equity markets but are still nowhere near pre-March levels. This is a clue that credit conditions will worsen again and that the trend in cash hoarding will intensify.

Bloomberg Barclays Global Aggregate Credit Index


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