23 October 2018
Bank of Japan has adopted negative interest rate as ongoing monetary easing measures have had limited effect. Photo: Bloomberg
Bank of Japan has adopted negative interest rate as ongoing monetary easing measures have had limited effect. Photo: Bloomberg

How to play a negative interest rate market

The Bank of Japan (BOJ) on Jan. 29 adopted a negative interest rate for the first time.

The question on most people’s minds is why.

The long answer is that the 2 percent inflation target is difficult to achieve with the consumer price index up just 0.1 percent.

The government needed a more aggressive policy to stimulate investment and consumption.

In fact, many European countries have made good progress with negative interest rates. These include Switzerland, Sweden and Denmark.

A negative interest rate kills two birds with one stone.

In this case, it forced the Japanese yen down to 120 from 115 against the dollar, making Japanese exports more competitive.

At the same time, it signaled the BOJ’s determination to tackle deflation.

The BOJ injects 80 trillion yen (US$679 billion) of capital into the market every year, a level similar to new issuance of annual government bonds which usually are snapped up by other central banks.

A negative interest rate came about because ongoing monetary easing measures have had limited effect.

Investors should sell bank stocks in the short term as the negative interest rate is expected to hurt their profitability.

Meanwhile, the property market is likely to benefit from the BOJ move.

A weaker yen boosted consumption by foreign tourists above 4 trillion yen last year, exceeding government targets.

Hotels have been grappling with a shortage of rooms.

With a negative interest rate environment, the yen will remain weak, attracting more visitors, and banks will lend more, driving up spending and consumption.

Also, it will help reduce the cost of building hotels, shops and malls, benefiting property developers.

Investors will be encouraged to switch to high-return investment products such as REITs.

At present, Japanese REITs offer an annual return of 3.3 percent compared with a 0.7 percent yield for 10-year government bonds.

REITs with underlying retail or hotel assets are even more attractive.

European property stocks have outperformed their respective benchmarks since negative interest rates were adopted by European central banks in June 2014.

It has boosted property sales in Germany and also driven up consumption.

But in China, the government is resorting to the old way to bolster the economy by stimulating housing and auto sales. 

Meanwhile, investors should focus on oil prices in the short run.

Crude oil prices have undergone a correction after a 30 percent rebound and are likely to test US$26 per barrel in the near term.

If oil prices hold at US$26, that will become the floor price. If not, oil could sink to US$20.

The markets have wrongly assumed that reduced oil inventory and robust demand from China will deplete stockpiles anytime soon.

However, the US shale gas industry has ramped up global oil supply at low cost.

The US will become a net oil exporter, which means oil pricing power will shift to the US from the Middle East.

Another wrong assumption is that OPEC is capable of keeping oil prices high — not with China’s economic slowdown being worse than expected.

OPEC nations could end up struggling for consensus over price levels.

In the meantime, oil prices are diving.

There is no telling where the bottom is until China’s economy improves.

This article appeared in the Hong Kong Economic Journal on Feb. 4.

Translation by Julie Zhu

[Chinese version 中文版]

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Founder and Managing Director of Pegasus Fund Managers Ltd.

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