Having traded at 117.53 on Monday the Japanese yen touched a low of 110.99 in what was an extremely volatile week for many markets. Bond markets were also volatile with the Japanese Government 10-year benchmark bond (JGB) at one point on Tuesday trading with a negative yield, the first for any G7 economy. At that point around 70% of outstanding JGBs were trading with a negative yield, although the 10-year JGB closed at 9bps on Friday.
Negative rates remain the order of the day in many countries with 5-year bond yields below zero in Sweden, Germany, Holland, France and Switzerland as well as in Japan. The common link between these countries is that they are all wealthy, and are all rated 4-star or more on our NFA rating system.
We have long spoken of our concerns regarding QE and the impact on the real economy especially with regards to deflation. With the Japanese yen trading close to its strongest level against the US dollar since Q4 2014, it is hard to calculate the true impact the strong yen will have on the Japanese government's target of 2% inflation. In our opinion, attempts to weaken the yen and raising inflation, assuming they could achieve this of course, will only make the Japanese population less well-off and rather than encouraging greater consumption, will only serve to perpetuate the current situation. Given that the Japanese invented QE and the zero interest rate policy (ZIRP) which has failed for the past 20 years, it is hard to understand why the rest of the world seems intent on following the same path. However, this is the route central banks seem intent on following, with even the US Federal Reserve examining the possibility of using negative interest rates.
What is even more curious is that no-one seems to have spotted the effect of such policies on current account balances, or more correctly, imbalances. The five countries with the world’s largest current account surpluses in absolute terms are China, South Korea, Japan, Germany and would you believe it, Holland! The current account balance measures the imbalance between savings and investments and countries with current account surpluses are usually considered to have UNDERVALUED currencies; they don’t need to weaken further. Furthermore, if QE actually worked and consumers spent more, the current account balances in these countries should be falling, not rising. The IMF current account forecasts for 2016 for these countries ranges from 2.8% of GDP for China to a staggering 9.2% for Holland!
In absolute terms these countries current account surpluses in aggregate total USD 917 billion. So, just in case you need any further convincing that QE doesn’t work, consider this. For every dollar of current account surplus, another country must run a deficit. This means that the rest of the world is amassing debts to just these five countries at the rate of 917 billion per year which is more than four times the annual GDP of Portugal!
We all know the difficulties faced by indebted countries, so why the current policies, which are creating greater global imbalances, are not raising more questions, is difficult to answer. Instead we prefer to answer the question as to what will happen if central banks continue with current policies. The answer is the world will end up with weak growth and falling inflation. That means most investors have too much exposure to risk assets, too much exposure to debtor nations and not enough in high grade bonds of the countries who can afford to pay them back.