David Kotok
Cumberland March 10, 2015



We will soon travel to Paris for Global Interdependence Center’s “New Policies for the Post Crisis Era” conference. The conference and accompanying activities are being held at the Banque de France on March 23, and the GIC delegate’s roundtable will be held at Bistro de la Muette on March 24, 2015. Any readers who can make last-minute arrangements to join us are most welcome. For more information or to register for this event, click here.  (

What a time for a discussion of Eurozone monetary policy and economic outcomes.

We have posted a G7 chart on our website ( . The chart depicts the interest rates on the two-year benchmark sovereign note and 10-year benchmark sovereign bond (technically the US Treasury item is a note, not a bond) for the G7 countries (United States, Canada, United Kingdom, France, Germany, Italy, and Japan). The chart shows that the highest interest rates are in the US. Look at the rest of the G7 members, the countries that constitute the large, mature capital markets of the world. It is evident that the world is upside down and backwards. The interest rates in the countries and currency zones where quantitative easing (QE) is still underway or about to expand immensely are lower by substantial amounts than the interest rates where QE has stopped and policy may be heading toward tightening.

Contrast the highest-credit-quality sovereign instruments. The US has the world’s reserve currency, and the US dollar is strengthening. A recovering US economy yields two percentage points more on the benchmark 10-year sovereign instrument than does Japan, where QE is ongoing and the debt-to-GDP ratio is three times that of the US. And the US note yields about 2% more than Germany’s bund (the benchmark for the Eurozone, where the European Central Bank [ECB] is launching an 18-month expansion of QE that will total in excess of €1 trillion). Under normal circumstances the differential in those interest rates would suggest that the dollar will be weaker over the next decade by about 2% per year against the yen or the euro. Yet all activity in the markets suggests the opposite. All pricing of futures, foreign exchange markets, and other asset categories suggests that this differential of 2% per year is backwards.

Think about future decision-making in sovereign debt allocation jurisdictions outside of the G7. Put yourself in charge of the sovereign wealth fund in a Caribbean nation, the Persian Gulf, or an Asian country. You have an allocation to high-grade government debt. No matter how large or small it is, it is large in terms of presence. A piece of your total fund will be in the highest-credit-quality sovereign debt. In Europe, you will favor Germany but will not go near a credit like Greece. You will also favor the Japanese yen, the US dollar, and the British pound. When you have to select among them, where will you apply your heaviest weight? You’ll overweight the US dollar and holdings of US government obligations at the expense of all others.

Whether you sell the others or take new-money flows into the US dollar is a separate question. On the other hand, the ECB is a buyer of whatever you want to sell. The Bank of Japan (BoJ) will help you if you happen to have any yen-denominated instruments left to sell. This policy acts to bid for US government securities and, by definition, all other US securities that tier from the US Treasury curve or are directly or indirectly related to it. Large global buyers of US-dollar-denominated high-grade bonds, including US government bonds, will be prevalent and highly active for the next two years.

Next, we tip our hat to Dennis Gartman for his clever use of the acronyms NIRP (negative interest rate policy), PIRP (positive interest rate policy), and ZIRP (zero interest rate policy).

What does that mean as the Federal Reserve moves away from zero to some low but positive interest rate? In the US, we go from ZIRP to PIRP. In the Eurozone they have gone from ZIRP to NIRP. Japan continues at ZIRP, as it has for the past several years.

Conversations in Paris will deal with the policy implications of this extraordinary distribution of global policy and the important impacts of ZIRP. One-third of the high-grade sovereign debt in the Eurozone and nearby European countries, like Sweden or Switzerland, is now trading around NIRP. The number of countries and the amount of debt at NIRP are both likely to grow. What does that mean for the suppression of yields worldwide? How will it affect asset allocations with traditional compositions that have not had to change much for the last 50 years but must now change radically? What do these global policy moves mean for the US, its economy, financial markets, and asset pricing?

What we do know going into the Paris conference is that the single most enduring element in valuation of financial assets is the interest rate. The basic construction of asset pricing starts with the riskless interest rate. And now we have the greatest distortion in interest rates that the world has ever seen.

At Cumberland Advisors, we have taken the position that low interest rates mean rising asset prices on a sustained basis. That is true for stocks and all other related asset sectors and categories. We see the US using 2015 and 2016 to move from ZIRP to PIRP. That does not necessarily mean a large increase in rates. It does mean something above zero. In the context of the rest of the world at ZIRP or NIRP, it means that the higher the US goes with PIRP, the greater the inflows into the US currency, seeking higher yields.

In Paris, we will discuss NIRP, PIRP, and ZIRP. I hope you will join us. We will have lots to say upon our return to the US.

Meanwhile, we are repositioning and reallocating within portfolios and changing sector choices because of NIRP, PIRP, and ZIRP in global markets. Clients will see this activity in their accounts. Currently, cash in the US core model is 35%. It has been that way for about a week. This is a temporary change. In the broad-based US model it is about 16%. The idea is to rebalance and capture the dramatic effect of the abrupt currency changes and to be ahead of the J-curve effects.

In the global models we have raised our foreign weights, lowered the US, and are over half currency hedged in the international part. We will write more on J-curves but cannot take the time to do it now. Portfolios come first, writing is second.

David R. Kotok, Chairman and Chief Investment Officer

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