Starting with the US Federal Reserve which has a clear dual mandate of low unemployment and inflation at or close to 2% it is clear that the employment part of their mandate has been fulfilled with an unemployment rate below 5% (some could argue this is due to factors such as people dropping out of the workforce). It is also equally clear that the second part of their mandate regarding inflation is clearly failing. Whilst the FED`s belief that inflation will eventually pick up, they may be somewhat deluded given the weak wage growth and very modest US GDP growth of around 2%. Other factors such as the much anticipated fiscal stimulus from Washington (tax cuts and infrastructure spending) look to be delayed until next year at the earliest (some are even saying 2019 after the US mid-term elections).
We fully expect the Federal Reserve to move at a snail’s pace in terms of interest rate rises and balance sheet reduction given the rather moderate nature of growth in the US economy.
If the Federal reserve is moving at a snail’s pace then the ECB is likely to move at the speed of a sloth given their single mandate of price stability with inflation at or close to 2% which they are significantly away from at the moment. The recent rise in the EUR especially against the USD will also be somewhat problematical for the ECB as if it lasts it will likely mean a somewhat further undershoot of their inflation target. The strong EUR will make imports cheaper and a prime example is the oil price together with other commodities which are important input costs for many European manufacturers. Whilst not in their mandate, it is evident that the ECB also looks at the Eurozone unemployment rate which is close to 10% and with youth unemployment north of 20% in many Eurozone countries it would seem somewhat insane to expect the ECB to move towards an aggressively hawkish monetary policy. We are completely aware that that recent strength in the EUR has been partly down to expectations that the ECB will start to discuss reducing their balance sheet at the September meeting however; talking is not the same as doing and investors would do well to note Mario Draghi’s protestations that it is way too early to think about a less accommodative monetary policy. The other side of the equation is the weakness of the USD due to the incessant media headlines and investigations surrounding Trump. At some point the guy is likely to catch a break! So why have markets become more volatile if we are right?
Perhaps the best way is to use an analogy. If you tell a heavy smoker that they are going to be forced to quit the immediate reaction is likely to be one of increased nervousness and heavier tobacco consumption. If, however you then took one cigarette away from their packet every 2 months the reduction would be very gradual and perhaps not even noticed. This is the magic trick that the US Federal reserve will attempt to perform over a long period of time.
Whilst many commentators have suggested that Central banks will take away the punch bowl from markets we view it more as the punch bowl will be less spiked. Instead of three bottles of vodka in the punch there will only be two!
Your Wealth at a Glance.