James Bevan: The Fed and ECB’s divergent paths
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James Bevan
At our “all staff” briefing this week, we discussed that the European Central Bank was expected to drive Euroland interest rates even further into negative territory when its policy-making committee met last week we did indeed get further easing by the ECB, although not by as much as some had expected.
With the prospect that the Fed will deliver its first hike on 16th December, after the upcoming Open Markets Committee meeting, we have highly divergent policy.
Divergence of policy is not new, with the Fed ending its QE campaign at the end of October 2014, and ever since then, there has been much chatter about when the Fed might proceed with a first hike of the Federal Funds rate.
Equally the ECB had cut their deposit rate for bank reserves from zero to -0.1% on 11th June 2014, and again to -0.2% on 4th September 2014. Last week, the ECB Governing Council lowered this rate again, and also implemented a QE programme at the start of this year. So while the Fed’s balance sheet has stopped expanding since late last year, the ECB’s balance sheet has increased by €515bn during the first 10 months of this year.
Results show
Photo (cropped): Curtis Garbutt, Flickr
One result is that the euro is down from last year’s peak of $1.39 on 6th May 6 to $1.06 currently. The decline in this key currency has certainly contributed significantly to the 19% appreciation of the trade-weighted dollar since 1st July 2014.
On balance, the strong dollar seems to be weighing more on the US economy than it is lifting the Euroland economy. It is also depressing commodity prices, which is weighing on the global economy as commodity producers and exporters are forced to reduce payrolls and capital spending.
In other words, the divergent paths taken by the Fed and the ECB are still leading to the same outlook for the global economy – secular stagnation.
The conclusion may be that the Fed won’t be able to stay on hiking tack next year. Thus, we have commodity prices still falling freely.
The CRB raw industrials spot price index is down 27% from last year’s peak on 24th April, to the lowest reading since June 2009. It remains highly correlated with the inverse of the trade-weighted dollar.
The drop in commodity prices is weighing on the Emerging Markets MSCI stock price index, which is down 5.8% ytd in local currencies. With the global context in focus, US exporters are suffering.
As a sort of illustration of the difficult times, West Coast ports’ outbound container traffic is down 11%yoy through October based on the 12-month sum of this series and it tends to be highly correlated with real export data. Equally illustrative, we have the strong dollar and weak commodity prices hitting some of the biggest US exporters, companies that manufacture mining equipment.
The forward revenues of the S&P500 Construction Machinery & Heavy Trucks industry (CAT, CMI, JOY, and PCAR) is down 31.7%yoy and 49.5% from its record high in 2012.
Tigers and Euroland
As for Euroland, the weaker euro hasn’t helped much thus far. Lending is picking up a bit, but MFI loans are up only 1.6%yoy through October and loans to nonfinancial corporations are up just 0.3%. More encouragingly, Euroland exports in euros are up 4.3%yoy through the three months ending September. In contrast imports have been flat since 2011, suggesting that the domestic economy remains stagnant.
Also receiving very little benefit from the strong dollar are Japan and the Asian Tigers. The yen is down 37% since late 2012. Japan’s industrial production rose 1.4%mom during October, but is down 1.4%yoy and is up just 4.8% since October 2012. Household spending fell 2.4%yoy during October – and over the past year through October, the CPI is up just 0.3%, or 0.7% excluding food, beverages, and energy.
Industrial production indexes have hardly moved since 2011 for the major Asian markets. Thus, from October 2011 through October 2015, production has been -2.1% for Singapore, +1.4% for South Korea and +5.4% for Taiwan.
Weighing it up
On balance, the strong dollar seems to be weighing more on the US than it is benefitting the rest of the world.
The real problem is that there are lots of forces weighing on global economic growth that can’t be offset by declines in the euro, the yen, and other currencies.
Easy monetary policy is not boosting demand largely because it’s been easy for a very long time, resulting in high debt burdens that depress demand. Meanwhile, easy money has facilitated the expansion of excess capacity, which has been very deflationary, particularly for commodities.
Then we have demographic trends around the world that are depressing global growth, with people living longer and fertility rates falling. This may be good news for the planet eventually but are stressful for now. Even more disruptive in the near term, we have technological innovations that affect lots of business models and provide ways to replace workers with automation and robotics.
The net result is that easy money can’t fix all of the problems, and might actually exacerbate them. Currency devaluation may also not work with the ECB’s campaign to drive the euro lower likely to have the same poor outcome as the BoJ had with depreciation of the yen.
Negative interest rates also could backfire – financial institutions may shun central-bank reserves in favour of cash stored in vaults, freezing the flow of capital and if negative rates get passed on to a wide range of big and small depositors, businesses and consumers may hoard cash too, denting banks’ profits.
Equally, as a behavioural response to low money rates, savers may save more. This is a tricky environment for businesses and investors. The watch words for both are a focus on sustainable growth and sticking to quality.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
* CCLA is a supporter of Room151
Federal Reserve Photo (cropped): Curtis Garbutt, Flickr.
