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@TheCorner – Are We Sure This is Good News?

Bank of Japan Adopts Negative Interest Rate Policy

“Recently, however, global financial markets have been volatile against the backdrop of the further decline in crude oil prices and uncertainty such as over future developments in emerging and commodity-exporting economies, particularly the Chinese economy,” the BOJ said in a statement accompanying the decision.

“For these reasons, there is an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected.”

By: Ken Reinhart

The Bank of Japan (BOJ) cuts interest rates to negative for banks parking their excess reserves at the Central Bank.  This is an all-out attempt to motivate (force) banks to loan out their excess reserves rather than park them.  Said another way, this is the Central Bank’s way of twisting their member banks’ arms and pushing them to lend whether or not the member bank’s feel comfortable with lending to borrowers who are operating in a highly questionable economy.  They are essentially saying look, if you do not lend these excess reserves, regardless of your economic assessment and follow-on business decisions in light of your concern over your customer’s viability to service said loans, we will be taxing (penalizing) you for not doing so.

This pull-forward demand process attempts to bring forward demand via access to more debt and ultimately places an even larger noose around the structural health of the economy via a strangling debt burden.

(Pull-forward demand?  Let’s say you have been aiming for an addition to the homestead (as an example) and have been saving for this of which you expect to put in place in two years say with funds saved out of earnings.  The local loan shop is incentivized to offer more loans (think excess reserves are now “taxed” by the central bank) and makes terms quite interesting to you current day.  You decide to pull the trigger and start the project now with debt paying for the project rather than future savings.  The demand you expected to put in place economically speaking in two years has been pulled forward to current day.  In addition, with this act, your balance sheet now reflects more debt of which you are burdened with servicing and paying off – with interest on said debt.)

This – ultimately – places even more over-indebted deflationary pressures on said economy.  It also places more pressure – ultimately –  on the inability to experience even a whiff of deflation in the economic system lest it crashes the financial structure of the system.  This then leads to ever greater acts of desperation to do nearly anything to avoid deflation such as we have now seen with the enactment of negative interest rate policies.

And the slippery slope continues of doing anything necessary to avoid deflationary pressures which end up sowing seeds of more deflationary pressures down the road.  Negative interest rate policy actions are extreme measures but like most slippery slope processes (in any endeavor) extreme actions are no longer seen for what they really are (extreme) but rather are ever more collectively viewed as normal and acceptable.  Speaking to this slippery slope we now have two major global central banks that have enacted negative interest rate policies – the European Central Bank (ECB) and now the Bank of Japan (BOJ).

Does this sound like a long-term structurally healthy act to take?  Does this sound like a desperate move to do nearly anything to pull forward aggregate demand via more indebtedness within the economic structure?  Does this also sound like yet another act within the global currency debasements to aid exports with a cheaper currency and also help to import inflation?

The last question is the true crux of topic and policy actions.  On a global basis no central bank/nation desires a strengthening currency as policy makers are hell-bent on trying to support their domestic economy via a weaker currency.  This allows them, on a pricing basis of their goods and services, to be cheaper in foreign markets – hence aiding their exports.  In addition, on that important deflation topic, a weaker currency essentially helps push deflation off their shores with the end result being higher priced goods coming onto their domestic market via higher priced imports in light of their weaker currency.

Speaking to the currency front, the Yen dropped significantly while the U.S. dollar rose rapidly with the release of the BOJ’s actions.  This places additional deflationary pressure on the U.S. domestically while aiding inflationary pressures domestically for Japan in light of the currency moves after the BOJ’s release.  Per the header excerpt, the initial currency reaction was the intention and the expected result – no surprise here in terms of currency market reactions.

With this, it will be ever harder for the FED to continue an interest rate hiking campaign while two major central banks have negative interest rate policies in place resulting in a stronger U.S. dollar.  If this turns into a continuing upward trend from here for the dollar they will be unable to raise again.

As stated, this stronger dollar places additional deflationary pressures on the U.S. domestically.  In addition, economic results domestically have been weakening exemplified by Friday’s weak GDP results.  All together, a stronger dollar, weakening economic results and raising interest rates will not play well together which means something will have to give.  It will be the higher rates that “gives” if the other two continue.

Interestingly, U.S. markets applauded Friday’s release from the BOJ with a strong trend day throughout the days’ trading.  With the above as a reality component of said policy actions it may not be as good of news as the kneejerk reaction suggested.  Time will tell and we will monitor the inter-market actions closely and position accordingly be it conservatively or aggressively with whatever direction the markets want to take from here.

One thing is certain, as it pertains to global central bank policy actions, we are and have been on a slippery slope where historically unthinkable actions are ever more acceptable and viewed as normal.  With this, markets will have reactions in all directions but the trend of said directions is what will act as a significant guide for us.

Ken Reinhart

Director, Market Research & Portfolio Analysis

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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