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Diverging paths; the Fed and the ECB

Photo: Shutterstock

Photo: Shutterstock

Following the recent political noise, primarily the recent political saga in Italy in which markets rattled on the uncertainty surrounding a possible political deadlock, now markets shifted their focus on two very important Central Bank meetings. This week the Federal Reserve (Fed) and the European Central Bank (ECB) gave further insight on their monetary decisions in line with the macroeconomic aspect.

On Wednesday, as expected the Fed hiked rates by 25bp, primarily supported by the solid employment numbers, inflation figures close the targeted levels and strong economic growth. In addition, the relatively unaccepted move, which to a certain extent markets were already anticipating, was the additional possible rate hike in 2018.

In my view, the additional hike is warranted given the sustained positive macro data. That said a faster than expected pace in rate hikes would imply tougher market conditions for investors. The initial reaction, should technically be a stronger dollar, which might ultimately be detrimental from a competitive front and this hinders the possibly of economic growth stability. In this regard despite economic data might point towards tighter monetary decisions the Fed will definitely monitor economic activity. Let’s not ignore the fact that the U.S. economy is primarily consumer spending-circa two thirds of GDP, and thus it can’t ignore the impact its decisions have on global financial conditions. At this point, I cannot see the Fed rock the boat by taking fast tightening monetary decisions.

On the contrary, the ECB is travelling at a very different speed, it is at a much earlier stage of its monetary policy cycle. In fact, it is still very actively engaged in quantitative easing (QE) and the possibility of hiking rates this year is still at the end on the list of the agenda. It is no secret that the QE programme is widely expected to end this year, however as opposed to U.S. policy makers the ECB has to face the recent soft data. In fact, in yesterday’s meeting the ECB stated that they will exit QE, but also claimed that interest rates will remain intact for a year.

Macro data in Europe has disappointed of late, with both hard and soft data on a downward trend. On the inflation front, the high print recorded in May, when Eurozone CPI hit 1.9%, gives the Governing Council enough momentum to reduce QE purchases, but it’s likely to be only a temporary spike and should partially retrace by year end. Core inflationary pressures, meanwhile, are still subdued. Against this backdrop, even though QE may be coming to an end, the ECB will keep a cautious tone in the months ahead.

Currently, the ECB is facing tougher decisions than the Fed, as it needs also to take in account the decisions being taken by the Fed and the impact such decisions carry primarily on the exchange rate and thus on the economy’s competitiveness. As I have opined in previous writings, 2018 will be a bumpy year for investors coupled by a diversity of factors, which however will create opportunities. If diligent, such bumps will proof to be winning venues for investors.

Disclaimer: This article was issued by Jordan Portelli, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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