December: A key test for divergent policy
Thushka Maharaj, Global Strategist, Multi Asset Solutions, JP Morgan Asset Management
When this year started, the market’s view—and ours—was that central bank divergence would be driven by a hawkish tilt at the Fed and easy or easier policy from other central banks. Instead, divergence has been largely driven by central banks erring on the dovish side.
Central bank dovishness has been one of the biggest surprises of 2015: a larger-than-expected QE programme by the European Central Bank (ECB); the surprise currency devaluation by the People’s Bank of China (PBoC); the Swiss National Bank’s (SNB) removal of the Swiss franc’s foreign exchange peg to the euro along with deeply negative rates; the Bank of England’s (BoE) stubborn focus on disinflationary trends; and even—dare we say it—the Fed and its moving goal posts that consistently delayed rate hikes throughout the year.
This year has revealed the potency of the currency channel in a low, uneven global growth environment. December could well be different and usher in a period of active policy divergence. Not only is the FOMC laying the groundwork for the first rate hike in over nine years, but the ECB is contemplating taking its policy rate further into negative territory.
This year has shown the difficulty of one central bank leading the charge to higher rates when every other central bank is easing policy. Up to now, even the dominant Fed could not escape this trap. But is that set to change? We expect so.
The FOMC’s explicit reference to “the next meeting” at the October meeting and the subsequent commentary from Fed Chair Janet Yellen about December being a “live possibility” tell us that merely a continuation of current data momentum should persuade the Fed to raise rates. The market is coming around to this idea.
In contrast, the ECB has once again proved surprisingly dovish. Despite a consistent improvement in domestic economic data, the persistently low level of inflation and appreciating currency set off alarm bells at the ECB. Further easing may be an insurance policy, given Europe’s exposure to emerging markets; or, more likely, the central bank is seeing the merits of pro-cyclical easing to reduce the risks of secular stagnation and ensure the economy reaches escape velocity.