Central Banks Of The World Are Now Aligned

The central banks of the world have now aligned. The Bank of England has launched a "forward guidance" approach and committed itself to very low short-term interest rates for an extended period of time. The ECB (European Central Bank) has done the same. ECB President Mario Draghi's comments parallel an earlier period of Federal Reserve history when Alan Greenspan used the words "extended period" to denote an open-ended stimulative phase.

We think about it in the following way. Here we are with all G4 central banks involved in forward guidance, a commitment to very low short-term interest rates, and with an extended period lasting for the next several years. The G4 is important. The euro, yen, pound, and dollar are now aligned at a near-zero interest rate. They are all committed to forward guidance and have determined in various ways that change in this policy is not likely to occur before 2015. Remember that “tapering” continues these very low interest rates and is still a form of stimulus.

This course has enormous implications for investors. It is important to realize that these four currencies – along with those that are (1) aligned, (2) have managed currency arrangements, or (3) have currencies linked with them –constitute about 85% of the world's capital markets. Countries like China or Chile manage their currencies in relation to the US dollar and other currencies. Switzerland has a base threshold tied to the euro. The Hong Kong dollar is managed by a currency board and is pegged to the US dollar. Bermuda does the same as Hong Kong.

When you look at the world's enormous financial system, the vast majority of wealth is deployed in markets that are part of the G4 or linked to it. All the other places are nice to visit, but as a practical matter, G4 drives worldwide policy.

The G4 is now publicly and profoundly committed to near-zero, short-term interest rates for at least two more years. That commitment might turn out to be longer. It won't be shorter.

This development is bullish for investors. It means rising asset prices will continue and the short end of worldwide yield curves will remain anchored near zero.

At Cumberland, we remain fully invested. We think the US economy is recovering gradually. The labor report today added to the evidence. Therefore we want to participate in stock markets through our ETF strategies.

In the bond market, we think tax-free bonds and the sell-off of tax-free bonds is overdone. Munis are cheap. We are lengthening duration on the buy side of that asset class.

On Thursday, we celebrated the 237th birthday of America. The outlook is gradually improving in a sustainable way. The Federal Reserve appears to have resolved some of its errors in communication and is trying to do better at articulating its policy direction. The rest of the world is aligned with its course.

BY David R. Kotok