Japan Fuels Currency Hedged, Bond ETFs

The Bank of Japan is back at it. The central bank, which is well-known for its propensity to implement aggressive, unconventional monetary policies, did it once again on Friday.

Led by Governor Haruhiko Kuroda, the Bank of Japan narrowly voted to unveil negative interest for the first time. The BoJ called its policy "quantitative and qualitative easing (QQE) with a negative interest rate."

Specifically, the Bank of Japan will apply a -0.1% rate to a portion of financial institutions' reserves at the central bank. At the same time, the BoJ will continue with its asset purchase program, with a target to buy 80 trillion yen worth of government bonds and 3 trillion yen worth of ETFs annually.

Negative Rates Not New

While a first for Japan, negative interest rates are not unprecedented. The European Central Bank, along with central banks in Sweden, Denmark, and Switzerland, have all experimented with negative rates.

Though still unclear whether this policy to charge banks for holding cash is effective, the Bank of Japan believes that it will help spur inflation to its 2% target. The BoJ said it could slash rates further into negative territory to achieve its objectives.

Most economists, however, believe the action will have limited impact on boosting growth and inflation in Japan.

"I think these efforts in Europe and Japan are failures," Richard Koo of the Nomura Research Institute, told Reuters. "The private sector is not borrowing money at any interest rate. This entire exercise is not going to work."

Related Article: Japan Goes Negative; Economists Scoff

Currency-Hedged ETFs Outperform

In any case, the knee-jerk reaction in markets was a bullish one. "Any time central banks push interest rates lower, stocks applaud it," John Caruso, senior market strategist at RJO Futures, told CNBC.

Japan's Nikkei 225 stock index jumped 3.1% thanks to a 2% decline in the Japanese yen against the U.S. dollar. A cheaper yen makes Japanese exporters more competitive.

The iShares MSCI Japan ETF (EWJ | B-98)―the largest U.S.-listed Japan ETF, with $19 billion in assets―rose, but only by 1.7%, due to the sagging yen-dollar exchange rate.

On the other hand, the iShares Currency Hedged MSCI Japan ETF (HEWJ | D-42) and the WisdomTree Japan Hedged Equity ETF (DXJ | B-71) both gained about 3.8%. By hedging their currency exposure, HEWJ and DXJ were able to capture the entire rally in Japanese equities and avoid the negative hit from the declining Japanese currency.

1-Year Returns For EWJ, HEWJ, DXJ

The Bank of Japan's new negative interest rate strategy certainly puts currency hedging back in focus for overseas investors interested in investing in the country. If the BoJ continues to aggressively ease, forcing the yen lower, currency-hedged products should outperform their plain-vanilla counterparts.

Bonds Hit 2016 Highs

Along with equities, the other asset class to see a big boost on Friday was bonds. Japanese bonds surged, sending the Japanese 10-year bond yield to a record-low 0.1% (bond yields move inversely to prices).

In Germany, the 10-year bond yield hit 0.32%, the lowest level in nine months, and in the U.S., the 10-year yield hit 1.90%, the lowest level in four months.

10-Year Government Bond Yields

Exchange-traded funds that track developed-market government bonds were all big winners today. The DB 3X Japanese Govt Bond Futures ETN (JGBT), a thinly traded but unique product that tracks Japanese bonds, surged 4.5% on the session. The ETN has steadily risen since its inception in 2011, returning 41.9% in that period and 5% year-to-date.

In the U.S., two of the most popular ETFs of the year―the iShares 7-10 Year Treasury Bond ETF (IEF | A-55) and the iShares 20+ Year Treasury Bond ETF (TLT | A-83) both advanced today―gaining 0.5% and 1%, respectively. On a year-to-date basis, they are respectively up 3.3% and 5.9%.

1-Year Return For JBGT, IEF, TLT