Stocks rise to end the week and turbulent month on a strong note. The S&P500 and the Dow Jones each rose 2.5% to 1,940 and 16,466 respectively. The S&P500 rose 1.7% this week to trim the months liosses to 5.1%. The VIX continued to trend downward towards the long term average of 20 closing at 20.13. Contributing to positive sentiment today was the BoJ which announced that it would adopt negative interest rates in order to restore growth and inflation. While the markets had been expecting some form of stimulus negative interest rates were not anticipated. Following the announcement the dollar rose 1.9% against the yen to Y121.68 and the broader dollar index gained 1.1%. Oil prices continued to rebound with Brent rising 2.5% to $34.74 and WTI gaining 1.2% to $33.62 as rumors continue about a possible Opec production cut with China. Economic data in the US showed that GDP grew 0.7% at an annualized pace in the fourth quarter which was slightly below expectations. In the US Treasury yields fell with the 10 year losing 6 basis points to 1.92% and the two year losing 4 basis points to 0.78%. This is because investors expect that given the widespread easing going on around the world including the addition of Japan, the Fed will not be willing to raise rates as they had previous hoped. Consequently gold prices rose as investors price in lower rates for longer.
The Bank of Japan joins the ECB and the Swiss National Bank as central banks that are using negative interest rates in order to bring down the respective currencies and lower borrowing costs to spur growth and inflation. These drastic easing measures from the BoJ have restored share prices in equity markets and are aimed in part to offset the negative effects of falling oil prices. This unprecedented level of monetary easing going on around the world at the same time runs the risk of currency wars in which countries actively seek to depreciate their own currencies in order to boost exports and growth. In Japan’s case the BoJ is trying to boost inflation which is currently running at just 0.2% annually. Markets are losing faith in the central bank’s ability to reach the 2% target, which was just pushed back another six months in the first half of 2017.
Japan’s rate entered negative territory in spite of previous statements made by the governor that rates would never drop below zero. The policy change for the BoJ does not effect existing deposits and loans, only deposits and loans that are accepted after the announcement. This is contrary to the way negative interest rates were imposed in Europe, and analysts expect it may limit the short term effects of the program. The biggest loser in the trend of competitive devaluations is arguably the United States, as the dollar has appreciated heavily along with weaker currencies everywhere around the world. The problems associated with this are seen in the fourth quarter GDP report as growth was inhibited by a large trade deficit (a result of a stronger dollar). In Japan asset purchases will remain at Y80tn (or $660bn) each year along with the -0.1% on excess reserves held at the central bank. Other countries such as Sweden, Denmark, and potentially Australia, and Norway are expected to further cut interest rates in the months ahead.
Energy sector debt will continue to show signs of deterioration in the months ahead as producers and suppliers continue to struggle with low prices. US Shale Solutions recently announced that it would restructure one of its debt issuances with a 57% haircut to investors. The amount of distressed debt in the energy sector is growing, and coupled with potential illiquidity issues in the market, some people believe that the struggles facing energy names could spread to other areas of the credit markets.