The actions of the Federal Reserve under the guidance of Chairman Bernanke on Wednesday evening have clearly boosted equities and risk assets and weakened the USD. As I see it however, it is not as straight forward as that.
The Federal Open Market Committee statement following the January meeting came with the inclusion of information relating to the interest rate path expectations of the Federal Reserve board members. As you would expect the forecasts covered all bases with some expecting interest rate normalisation to begin at the end of this year and some expecting unchanged rates into 2016. Despite the fact that the range of interest rate forecasts by the individual Fed members was from 0.25 percent to 2.75 percent at the end of 2014, the statement accompanying the unchanged rate announcement clearly stated the conditional expectation is that Fed funds will remain unchanged at its current 0-0.25 percent target through 2014.
What does this mean?
Effectively the low rate pledge from the Fed is a further move to monetary accommodation; USD bears may even claim monetary debasement. It falls short of outright QE3 it could be argued that the impact of the extended “extended period” language is tantamount to QE 2.5.
In addition to this the Fed also gave some further clarity towards its management of the dual mandate (of full employment and stable prices) in their governance of monetary policy and in relation to that dual mandate the statement “the committee expects to maintain a highly accommodative stance for monetary policy” replaced a sentence that warned about the “close attention to the evolution of inflation and inflation expectations”, suggests that perhaps employment is the dominant driver of policy at the current juncture.
Race to the bottom?
The reality of the situation is that the world’s two most powerful central bankers are, perhaps unwittingly, in a race to the bottom for their respective front end interest rates. Both are driven to a certain degree by the potential implications of a slowing global economic backdrop, however, there are a number of distinct differences between the motivations of the Fed and the European Central Bank.
Whilst Bernanke was quick to point out that he is “not ready to declare that the US has entered a new stronger phase” he did acknowledge that the “US economy is getting stronger”. US interest rate policy could be deemed to be aimed directly at stimulating growth in the US economy (arguably as a result of the facet of the Unemployment part of the dual mandate). In Europe Mario Draghi’s widely heralded ‘Helicopter drop’ of funding via the ‘non-standard measure’ of the unlimited 3 year LTRO (refinancing operation) was aimed at preventing a complete collapse of the bank funding markets and the functioning of the European financial sector. In my mind this highlights the differential, not just in terms of policy lag, but of growth trajectories between the US and the Eurozone.
“We are not yet over the worst of the crisis” – Wolfgang Schaeuble
In the short term the accommodation of the Fed will likely weaken the USD, however relative to the EUR I feel that this is a very weak argument. German Finance Minister Wolfgang Schaeuble’s rhetoric adds to the argument that the Eurozone is still at the stage of averting further declines. The US (and others) are in my opinion in the process of encouraging and supporting the recovery. I continue to believe that in the near term this gives an investment bias towards the US and away from the Eurozone.
Later in the year when the focus of the markets attention comes back to the political shenanigans surrounding the US election and the fiscal deficit reduction plans, there may be a case for USD weakness. However until that point the US deficit will likely take a back seat in terms of currency investment decisions, much as the deficit in Japan (predicted to breach the quadrillion Yen mark later this financial year) has since the onset of the financial crises.
Last breath for the EUR?
There is perhaps one more near-term positive on the Eurozone horizon and that is the potential for an agreement on the Greek debt swap. The legal ramifications of what constitutes ‘voluntary involvement’ in the debt renegotiations will likely go on for years if not decades, however an agreement (whether thought morally right or wrong) will be a sigh of relief for the Eurozone and likely the last breath for the EUR before it begins to submerge once more.