Are the paths of the Fed and ECB diverging further?

The Federal Reserve (Fed) and European Central Bank (ECB) both have a near zero interest rate policy (ZIRP). While the Fed ended purchases in its aggressive balance sheet expansion policy, or Quantitative Easing (QE), the ECB only started a similar program earlier this year. Last week, the Fed decided to keep interest rates on hold, although mentioning a lift-off later this year. The ECB is reportedly considering increasing its QE-program. How likely is a further diverging path of both central banks? And what will this mean for investors?

Are the paths of the Fed and ECB diverging further?

Statements Fed officials don’t make sense

During the recent months, a number of Fed officials indicated that the September FOMC-meeting would be a good date to decide in favor of a first rate hike. We all witnessed last week that the FOMC could not pull the trigger. Fed officials Bullard and Williams declare now, a few days later, that a rate hike is still ‘appropriate’ (Williams) and that holding the rate in the last meeting was a ‘close call’ (Bullard). One might be surprised by these hawkish words just a couple of days after a much anticipated meeting. If it was really a close call, why was there only one vote in favor of a lift off? If a rate rise is really the right thing to do in 2015, why stressing the Fed’s inflation mandate in the recent FOMC-statement? The elaborations of Fed-chair Yellen after the meeting on inflation in particular offered a somewhat different picture. Also a blue dot in the economic projections which showed a negative interest rate raised some eyebrows. Despite all words indicating a lift off (probably more will follow the next days and weeks), we can seriously doubt 2015 will see a lift off. There are simply no data to expect in the coming time which may cause the FOMC to become ‘reasonable confident’ about rising inflation.

ECB ready to act

While the statements by Fed-officials could be nothing more than rhetoric, the words of ECB-board members may prove to have more substance. A number of central bankers came out this weekend and today to underline the ECB’s ‘readiness & decisiveness’ to act in expanding its QE program. Peter Praet, ECB’s chief economist reiterated that the central bank is ready to modify the program if further action is needed and referred to economic turbulence. Bank of Italy’s top economist Gaiotti said the ECB should not fall behind the curve in the battle against inflation. This matches with the words of fellow countryman and ECB-president Draghi during the press conference. The inflation data in the Eurozone remains very weak. We could see new measures announced in the ECB’s next meeting on October 22.

Impact for EURUSD and stock markets

But what does this all mean for investors? Probably the EURUSD will stay relative volatile, with movements of at least 100 pips per day. While statements by central bankers may have impact, counter moves could occur if US data stays weak. So a cautious position is required. The potential further diverging paths doesn’t mean it’s a one-way street of a weaker EUR compared to USD. In addition, a tightening stance of the Federal Reserve could drive US stocks lower. On the other hand, further stimulus by the ECB could be a driver for European stocks to move higher. The rotation of funds from US stocks to Eurozone stocks, which we saw in the first half of 2015, could get new traction. But there’s another player in the game: China. If data from this country remains poor, stimulus might not help for stocks…

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