Japan hit another milestone this week when its government five-year bond yields hit zero, and went negative for the first time in history. It joined Germany, whose five-year government debt went below zero just after the New Year.
This drop is in reaction to a continuing stream of data showing deflation around the world and slow growth. Oil prices, which have now slid by 20%, are the real culprit.
What we are watching very carefully is how these zero and sub-zero interest rates will be implemented and what their effect will be on the markets. Just this week, the Swiss National Bank made major changes to its monetary policy by abandoning its peg against the euro and implementing a deeper and more negative interest rate policy.
Next week, the European Central Bank meets and is expected to implement its own version of quantitative easing.
Lower oil prices and interest rates are a double-edged sword for the markets. They are a windfall for consumers. However, equity markets are responding negatively, showing extreme levels of volatility.
The uncomfortable fact is that this week ends with more questions than answers. Clearly Japanese and German bond yields cannot go down forever. But these are uncharted waters, so it’s hard to know when sanity will return to the markets. The Swiss National Bank move was a shock, and it will take a few days for the impact of these moves to be made clear.
Our view: Markets will settle down. They always do. However at this point, it’s unclear how soon this will happen. Be assured that we are monitoring this situation and will continue to update you as events unfold.
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