There was a time when central bankers in Europe and the United States behaved much like soldiers – always in step with each other. If the U.S. raised or lowered interest rates, Europe would quickly follow suit.
The days of monetary harmony are over. With their economies heading in wildly different directions, the gulf between the monetary policies of the world’s two most powerful central banks has never been wider.
While the United States has mostly recovered from the 2008 financial crisis, Europe is still reeling. Insiders at the European Central Bank figure the European continent is at least two years away from a solid recovery like that seen in the United States – and that recovery could yet be eroded if a crisis in Greece spreads to the rest of the continent.
The trans-Atlantic growth divide is widely expected to get worse before it gets better. Europe’s economic output, at around 1.5 percent, is likely to be about half that of the United States this year. The 19-nation euro zone’s unemployment rate, currently at 11.2 percent, is more than double that across the Atlantic.
After years behind the curve, the European Central Bank is finally reacting to the growing chasm. On Monday the Frankfurt-based ECB opened the monetary spigot further, launching a €1.14 trillion bond-buying program first announced in January and designed to pump cheap money into Europe’s economy. Interest rates in the euro zone were already been pushed to a record low of 0.05 percent in September.
“A number of emerging markets face tough times ahead. There could well be state bankruptcies in emerging markets within a year.”
The U.S. Federal Reserve did something similar more than six years ago. Now the Washington-based central bank is preparing to head in the other direction. Having ended its own bond-buying program last year, it is now getting ready to turn its taps off further by raising interest rates for the first time in nine years. Some economists think such a move from the Fed could come as early as June.
Currency strategists are preparing for massive turbulence ahead. The euro fell to nearly €1.08 per dollar on Friday, its lowest level since 2003. Less than a year ago it was still near €1.40. Many market watchers expect it could soon reach parity with the dollar for the first time since 2002.
Emerging markets are caught smack in the middle of the two economic powers. Europe’s aggressive easing moves have forced many countries to follow suit, either by lowering interest rates or purchasing assets to stop their currencies from appreciating against the euro and hurting their economies.
The U.S. move is likely to only make matters worse for these economies: Better prospects for making money in the United States are likely to prompt investors to take their money out of weaker developing markets and invest it back in the world’s largest economy.
Scott Mather, chief bond strategist for Pimco, told Handelsblatt that massive shifts in bond-market rates can be expected in coming months, as the Fed begins tightening monetary policy while much of the rest of the world continues easing.
“A number of emerging markets face tough times ahead,” said Mr. Mather, noting that Pimco has pulled out of a number of emerging markets. “There could well be state bankruptcies in emerging markets within a year.”
The world’s top central bankers seem to be undaunted by these global shifts. Insiders at the ECB are hoping that a cheaper euro will help the continent’s exporters, who can offer their goods at a relatively cheaper price.
Mario Draghi, the European Central Bank’s president, on Monday will oversee the launching of the €1.14 trillion bond-buying program in the 19 countries that make up the euro currency zone, using up the last major tool he has left to force the European economy out of a seven-year economic slump.
The ECB’s program, which is still heavily disputed in Germany, is similar to the “quantitative easing” program that was launched in the United States about six years ago and ended last year. The European central bank plans to buy about €60 billion in bonds and other assets each month until at least September 2016, and possibly beyond.
While Mr. Draghi has insisted that a weaker euro is a byproduct of his policies and not the ECB’s outright goal, many economists think otherwise.
“The ECB’s bond-buying program is really a devaluation program,” Jörg Krämer, chief economist of Commerzbank, told Handelsblatt.
Still, U.S. officials are unlikely to react for the time being. Interest rates have been at rock-bottom since December 2008. But with their economy moving ahead at full steam – the jobless rate at 5.5 percent is near full-employment – many feel the United States can afford to pick up some of the slack.
“It is more important for them that their trading partners get back on their feet,” said Thomas Mayer, a former chief economist of Deutsche Bank and now with the Cologne-based research group Flossbach von Storch.
Indeed, while there has been some speculation that the ECB’s easing move could delay an interest-rate rise in the United States, some market watchers now expect the Federal Reserve’s chairwoman, Janet Yellen, may start raising rates sooner rather than later.
While markets have generally priced in a move in the final three months of the year, Mr. Mather of Pimco said markets may be surprised by an earlier shift. Russ Koesterich, chief investment strategist of the world’s largest asset manager Blackrock, agreed.
“The Fed is closer to normalizing its policy than many investors seem to think,” Mr. Koesterich said.
Ms. Yellin has so far held her cards close to her chest, but many investors believe she will soon dare to make her goals more concrete, if only to ensure there is clarity before the Fed makes its next move.
The Fed has an interest in avoiding the kind of panic it provoked in the summer of 2013. At that time, many markets were caught off guard when the Fed said it would consider dialing back its own quantitative easing program. A cautious opening from then-Fed Chairman Ben Bernanke was enough to spark a sell-off in emerging markets. Many investors pulled their money, causing a collapse in the currencies of Brazil and India.
Investors say that communicating not just the timing but also the pace of any interest rate increases in the United States will be critical to avoid a similar crisis this year. Asoka Wöhrmann, chief strategist for Deutsche Bank’s asset management subsidiary Deutsche AWM, expects more than one increase before the end of the year – to 0.5 percent of 0.75 percent.
The direction is clear: Upwards.
Jens Münchrath leads Handelsblatt’s monetary policy coverage out of Düsseldorf, Anke Rezmer covers financial markets and investment funds in Frankfurt and Frank Wiebe follows developments on Wall Street in New York. Jan Mallien, Susanne Schier and Christopher Cermak also contributed to this story. To contact the authors: firstname.lastname@example.org, email@example.com and firstname.lastname@example.org