“Are we finished? The answer is no.” – Mario Draghi, ECB President
In last week’s Insight, The Long Hike, we discussed the timing and potential causes of a future rake hike from the US Fed. With quantitative easing on its way out, the next important step from US policy makers will be to signal to the markets that they are ready to begin raising interest rates. We still believe we are a ways off from that, but the momentum is certainly moving in the direction of tighter monetary policy here in the US.
Across the pond in Europe the situation is quite different, and monetary policy appears poised to move in the opposite direction as the US. For starters, the Eurozone economy is stagnant and slowing. Second quarter GDP came in at 0.2% (less than 1% annualized), with the area’s poster child, Germany, actually posting a -0.6% quarterly decline. Italy and France were also negative and appear to be slipping into recession.
Meanwhile, Eurozone unemployment remains elevated at 11.5%, with youth unemployment at a painful 23.1%.
Finally, inflation data in the Eurozone has consistently slid in recent months and is well below the European Central Bank’s target for the region of just below 2%. It’s deflation, not inflation, that is keeping European policy makers up at night these days.
What all of this means is that even as the US embarks on monetary policy tightening, the ECB is moving in the opposite direction and beginning to loosen monetary policy in the Eurozone. We’ve already seen a rate cut from the ECB earlier in the year, and many are speculating that a European-style quantitative easing program is right around the corner. Central Bank President Mario Draghi is famous for committing to “whatever it takes” to preserve the common currency and the regional economic union, and he is clearly willing to push monetary policy to further extremes in order to avoid deflation or an echo recession. He made this clear in a speech delivered to the Kansas City Fed’s Jackson Hole economic symposium in which he stated,
The risks of 'doing too little’ outweigh those of 'doing too much'—that is, excessive upward wage and price pressures.
In that same speech he also spoke out against the stiff fiscal austerity that has been a hallmark of the European response in the wake of the financial crisis,
It may be useful to have a discussion on the overall fiscal stance of the euro area, with better coordination of policies aimed at a more growth-friendly overall fiscal stance.
It would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this.
Most Americans feel that our domestic economic, fiscal and monetary policies are not producing the type of healthy and sustainable growth that we’d like to see long term. However, our economy and the current trajectory of upcoming policy changes is a bright spot on the global stage when compared to other developed economies. The normalization of monetary policy finally looks to be within striking distance for our Fed. With other regions of the world going in the opposite direction, this is something we can all be grateful for.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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