Paul Samuelson once witty remarked that central bankers were born with two eyes: one to watch the money and the other to watch the interest rates. Currently it seems that we are leaving in a world were Central Banks feel more like Cyclopes. Having only one eye, they are focusing on Japan, exactly where the escalation came from.
On January the 29th the BOJ cut its interest rate on new reserves to -0.1%, joining the less-than-zero club of economies; welcome to the new normal, the pay-to-save strategy already adopted by Sweden, Denmark, Switzerland, and by the European Central Bank. Clearly, the aim is to push banks lending and companies spending more. But for the Japanese economy, it is not so clear if the final impact will be positive.
Latest data shows a gauge of demand for home loans; moreover the demand for corporate loans advanced to a two year high, but the level remains below the one reached in 2006-2007.
At this stage, I believe that the currency war could go on, exacerbating further. It is already written that China is targeting the Renmimbi to a basket of currencies and the Yen is roughly 15% of that basket. The Euro counts for another 21%, and the BOJ dovishness will heap pressure on the ECB to act in March. On the other side of the Atlantic, the FED is now in difficult waters since the dollar appreciation limits any strong messages on the health of the economy; de facto, the market is sceptical about the chances of hiking rates up this year. If we have a look into the futures markets, we realize that the effective FED Funds rate for year-end, fell to about 0.55% that is remarkably down from 0.63% a week ago and it is below the level of 0.62% that would imply one more rate increase.
Anyway the combination of policy makers’ willingness to sustain the global growth, allowed the equity markets to partially recover the previous losses. On a monthly basis, the Nasdaq, for instance, fell 7.86% for its worst month since May 2010. During the last day of the month, stocks have been rallied; the positive sentiment after the BOJ decision has been galvanized by encouraging earnings reports, a better-than-expected Chicago PMI and stabilization in Oil price around 34 dollars per barrel.
Last “Rear View Mirror” suggests the reader to buy volatility, not only to protect its portfolio, but with the objective to identify something cheaper in that environment. Looking back, I believe that the correction that we have seen in this start of the year could have been affected by an overreaction. But if not confirmed by economic data, last price action on Treasury and Bunds suggests to us that the market is pricing a risk of recession. Looking forward then, I will consider “cash instruments” as a valid asset class. This is to reduce the volatility of our portfolio and, at the same time, to allow us to jump into the market at deep correction.