When it comes to monetary policy and economic growth, the United States and Europe are moving in different directions.
The Federal Reserve is unwinding its QE program and moving closer to raising its target interest rate, while the European Central Bank is becoming more accommodative. In addition, macroeconomic data show moderate US growth but only flat euro-zone growth. Clearly, their paths are diverging.
Last week, ECB chief Mario Draghi shocked Wall Street by cutting interest rates. But this move shouldn’t really come as a surprise given that the euro-zone economy has slowed to a crawl on the heels of a series of setbacks, including economic sanctions against Russia.
Recent data confirmed this lack of progress in Europe: A report on estimated second-quarter GDP growth in the euro zone showed that the economy experienced no growth. And last week the ECB downgraded their near-term growth forecasts for 2014 and 2015to 0.9% and 1.6%, respectively. Still, 2016 projections were revised upward slightly to 1.9%.
Deeper Repression
What does this news mean? It signals that the euro zone has sunk deeper into financial repression. The interest-rate corridor was lowered by 10 basis points, with the main refinance rate now at a record low of 0.05%. It seems clear that we’ve reached the end of conventional easing. The ECB is now preparing to begin asset purchases in October, but details haven’t been announced yet. The targeted increase in the ECB’s balance sheet remains very ambitious, but so far the ECB hasn’t put a lot of new monetary stimulus on the table.
Meanwhile, the US economy continues to gather steam as it nears the end of its taper timeline. In fact, while the ECB expects to start purchasing assets in October, the Fed plans to end its asset purchases in October. Not even last week’s underwhelming jobs report will divert the Fed from tapering and, eventually, tightening.
The Bigger Picture
Indeed, the August employment report indicated that the jobs recovery is taking a breather. But we haven’t seen any data that suggest that the US economic recovery has come off the rails. Keep in mind that the monthly jobs report is just one data point in a large mosaic of data that provides a picture of the US economy. Therefore, it won’t influence the timing, pace or scale of the central bank’s future actions.
Further, the recent trend in macroeconomic data remains encouraging. The ISM manufacturing and non-manufacturing indices for August revealed continued expansion. In other words, the latest jobs report seems to be a temporary outlier in a still robust underlying labor-market trend.
History Speaks
How should investors respond? We look to history as a guide. In the past six Fed rate-hike cycles since 1983, commodities and equities were the best-performing asset classes, according to my Economics & Strategy team colleagues in Frankfurt. Interestingly, all fixed-income segments, on average, also did well, with inflation-linked bonds and high-yield bonds leading the way by a wide margin.
One critical lesson we can learn from historical rate-hike cycles is the relationship between market returns and the degree of surprise caused by changes in monetary policy. Well-flagged and anticipated rate hikes have been digested rather well by most asset classes. Unexpected and poorly communicated hikes, however, took their toll on financial markets. With this lesson in mind, we look forward to clear communication from the Fed in the coming months.
Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.
A Word About Risk: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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