As markets focused on Chair Janet Yellen and the Federal Reserve’s (Fed’s) removal of the word patient from Wednesday’s statement following the latest FOMC meeting, Sveriges Riksbank Governor Stefan Ingves lowered the interest rate of Sweden’s central bank below that of the euro system banks. At minus 0.25%, its negative interest rate now exceeds the minus 0.20% rate paid by euro system banks to store reserves at the European Central Bank (ECB).
Our monetary policy discussions in Paris prepare us for the Global Interdependence Center’s (GIC’s) conference at the Banque de France on Monday and Tuesday, March 23-24.
These discussions include the ways in which this competitive force of negative interest rates is spreading throughout Europe. It can be seen in the Baltic region in countries like Finland, Sweden and Denmark, as well as Germany. It is quite prevalent in Switzerland. Negative interest-rate policies are spreading beyond the Eurozone.
In Lockstep With The ECB
There is another interesting fact about the Swedish announcement. Governor Ingves said that the policy will remain in effect through most of 2016. In other words, to protect or defend its own economy and to keep the Swedish krona from strengthening, the Riksbank has committed itself to a negative interest rate policy and quantitative easing (QE) in lockstep with the ECB. That move means the forces for negative interest rates are spreading throughout Europe and the commitment to QE in many of these countries is now extending for 1.5 years.
What happens after 1.5 years? These central banks do not immediately reverse policy and commence raising interest rates. It is unlikely that they start tapering the policy right away. We believe that the stage is being set for a zero and negative interest-rate policy in the entirety of Europe for a period that could last through the end of the decade.
This is a tremendous monetary force. It is extraordinarily bullish for asset prices because these prices are set by discounting interest rate mechanisms. When the interest rate is zero, the theoretical price of an asset is infinity, although we do not expect European assets to rise indefinitely or to infinite price numbers. We do, however, expect prices to rise for European equities, real estate assets, precious metals priced in these currencies, and other assets that can be priced off of a low interest rate. Persistently negative interest rates are bullish for asset prices.
Negative interest rates in Europe also suppress interest rates elsewhere in the world. An example of yield suppression may be seen with the recent euro-denominated bond sale of borderline junk credit Bulgaria, where 7-, 12-, and 20-year maturities sold at 2.2%, 2.7% and 3.3% respectively. Imagine, Bulgaria borrows in EUR/USDeuros at yields below those at which Fannie Mae can finance American dollars used for US government-backed housing.
Negative interest rates further induce competitive QE in countries that are willing to practice it. Hence we expect to see more QE in Japan.
The Trend Is Higher
A global force of substantial size spreading the negative interest-rate policy is bullish for worldwide financial assets. The corrections may be cyclical and shallow, but the major trend is higher. Risks rise as the trend develops, however, because the policy of negative interest rates cannot be sustained forever.
Cumberland Advisors is fully invested in our US ETF accounts. We are now more comfortable with this position because we are having face-to-face discussions in Europe. We remain underweight in the Energy sector. Our international ETF accounts favor currency-hedged positions. We have deployed more than half of the funds in currency-hedged structures. Our selection of countries and markets involves observing the influences of J-curve effects and how they will benefit those countries and markets.
We are watching the negative interest-rate spread to the bond markets of the world and act as a suppressing force. Even as the Fed may raise its short-term interest rate for the first time before the end of 2015, the upward spiking of long- and intermediate-term US interest rates will be tepid, not sharp, and indeed may not happen at all.
We will continue this discussion with our colleagues in Paris and then at the public conference on Monday. We recommend that discussions of this zero or lower interest rate occur at Le BaràHuitres. You may find it on boulevard Beaumarchais, near the Bastille and two blocks from the Place de Vosges. Soupe de poisson is a superb offering, especially on a cool spring day.
David R. Kotok, Chairman and Chief Investment Officer