Macro Weekly – ECB and Fed parting ways

by: Han de Jong

Macro-Weekly-28-November-2015.pdf (144 KB)

The ECB will likely provide additional monetary stimulus to the Eurozone economy this week, while the US Fed is set to tighten monetary policy before Christmas. It is extremely rare that the two most important central banks are moving in opposite directions. As a result, there is not much historic experience to help us predict how financial markets will responds. As both steps have been well flagged by the central bankers, the move should not come as a surprise. As a result, we are assuming financial markets will respond calmly, but there is a risk of rising volatility.

Mixed data not a game changer for the Fed

Last week’s US economic data was mixed. Q3 GDP was revised higher, personal income data was strong and initial jobless claims suggest that the labour market continues to tighten. On the other hand, consumer confidence weakened in November, at least on the Conference Board’s measure and several business confidence measures weakened in November.

This data alone does not suggest the Fed should be in a hurry to tighten monetary policy. However, with official interest rates at rock-bottom levels and the market attaching more than a 50% chance to a rate hike in December, we would be surprised if the Fed left rates unchanged. In fact, the Fed will most likely want to tighten monetary policy at a very slow pace. It is important therefore, that the process gets going.

Eurozone data more convincing, but ECB still set to ease further

Last week’s Eurozone economic data was actually more convincing than US data. The preliminary reading on the Markit PMIs was encouraging. According to these indicators business confidence strengthened in November in manufacturing and in services. The European Commission’s Economic Confidence indicator was unchanged in November, but Germany’s Ifo index of business confidence was up again in November. The so called ‘expectations’ component rose for the third consecutive month after falling in four of the preceding five months. My interpretation of this data is that Germany is coping well with slowing growth of world trade and of global growth of industrial activity. In fact, the German confidence data may suggest that an improvement of industrial activity is likely to emerge shortly. Eurozone monetary and banking statistics were also encouraging. Money growth accelerated in October and bank lending to the non-financial sector improved.

Despite these positive signals the ECB is likely to announce further stimulus this week. ECB President Draghi has more or less promised so much during the last two months or so and he has built a track record of delivering or even over-delivering on his promises. We expect a range of measures: a cut in the deposit rate from -0.20% to -0.40%, an increase in the amounts of paper the ECB is buying each month from EUR 60 bn to EUR 80 bn, an increase in the types of paper the ECB will be buying and perhaps an extension of the programme beyond September 2016.


Isn’t that odd?

Just looking at the data in the eurozone and in the US, one would not guess that the Fed will start tightening and that the ECB will venture further up the path of unconventional policies. One must bear in mind, however, that the US is further advanced in its recovery process. And with hindsight, the ECB may feel that it has been too tight for too long for no good reason. The world economy is vulnerable and geopolitical risks are significant. So perhaps Draghi just does not want to take chances. In addition, the ECB has undershot its inflation target for a considerable length of time.


We must bear in mind that it is very rare for the Fed to move in one direction and the key central bank in Europe to go the opposite way. The last time that happened was over 20 years ago. At that time, the business cycles in Germany and the US had been de-synchronised by German unification. It would seem to me that divergence of monetary policy is harder to justify this time. Having said that, central banks have provided much guidance that this is going to happen. As a result, we do not think markets will be taken by surprise and respond with great volatility.

A surprise to me

A few months ago, I was not expecting the ECB to cut its deposit rate further into negative territory. Now that Mr Draghi has more or less promised a further cut, it looks certain to happen. The ECB is also likely to introduce a novelty here as they are expected to introduce a two-tiered system with a more negative deposit rate for banks that keep large balances on deposit with the ECB. This must increase the chance that negative rates will become more widespread.