Japan’s initial move into negative interest rates is a baby step. However, it is the first step. And it triggered massive market responses for understandable reasons.
Observations about the BOJ’s use of negative interest rates are clear. The first step is not the last step. Instituting a small, 10-basis-point negative rate on newly created reserve additions is only the beginning of a policy change. The closeness of the vote, 5 to 4, suggests that the policy change was debated for a long time. It took the most recent information and weakness in Japan to move this board to a majority view in favor of this tepid first step.
What Comes Next?
The progression into negative rates is bullish for asset prices worldwide. As Ben Bernanke once indicated, if you discount the price of an asset indefinitely at zero, the asset price rises and becomes profitable. Imagine the same math applied when the interest rate discount mechanism is negative instead of zero. Mathematically, there are no limits when the discounting rate is zero or lower.
Europe is now likely to follow with a newer and lower negative interest rate. We expect ECB President Mario Draghi to move down to lower negative rates this spring. Other countries in Europe will have to face similar pressures pushing rates further into negative territory. This will specifically apply to Sweden, Denmark, and Switzerland. It will apply to others as well.
The world now sees the following currencies under negative interest rate policies: (1) the Japanese yen, (2) the euro, (3) the Swiss franc, (4) the Swedish krona, and (5) the Danish krone. The first two are large economic and capital-market forces. Switzerland is uniquely positioned in global finance, notwithstanding its smaller size.
We have five currencies and 23 countries in the world following a negative interest-rate policy today. The direction of that policy points toward more quantitative easing (QE), more negative interest rates, lower negative interest rates, and a suppression of interest rates throughout the entire global yield curve. The likelihood of that policy being in place for at least two or three years is very high. Additionally, the likelihood of those currencies weakening against the US dollar grows every day.
At Cumberland, we are nearly fully invested in the US stock market. Our international accounts favor currency-hedged positions, and the most successful and largest consistent international place has been Japan with currency hedges in place. The (O:ACWX) benchmark Japan weight is about 17%. At Cumberland, in our international ETF strategy, our total Japan weight is about 30%. Two-thirds of that Japan exposure is currency hedged.
We are in an extraordinary world. Those who are following regression methodology to create pretty multi-colored pie charts are missing out. To paraphrase Keynes, when things change, I change. Markets are headed higher. Maybe much higher.
David R. Kotok, Chairman and Chief Investment Officer.