Central banks have started 2015 with bold actions. The Swiss National Bank shocked with the unexpected end of the EUR/CHF 1.20 cap after Governor Thomas Jordan had confirmed his satisfaction with the program a month earlier. The sudden about – face drove volatility higher ahead of the European Central Bank’s (ECB) much-awaited quantitative easing (QE) announcement. ECB chief Mario Draghi promised to do “whatever it takes”; to save the euro in July 2012. Several months and a lot of internal negotiations later, he delivered a program tasked with preserving the eurozone’s unity through economic stimulus.
The United States Federal Reserve has had the luxury of a strong recovery that continues to gain momentum. The Fed’s biggest challenge has been managing market expectations. Chair Janet Yellen’s first year has further pushed the agenda she and former Chair Ben Bernanke designed at the end of 2013 starting with the bond-buying tapering announcement. In the fall of 2014, the program ended with market participants quoting Yellen’s words of “six months”; as the answer she gave to a probable start of interest rate hikes.
Strengthening Greenback a Complicating Matter
The USD kept gaining versus major pairs on the back of a growing momentum compared to the struggles of major economies with Europe as a prime example. The lack of meaningful action from the ECB meant that the EUR/USD kept heading lower but at a controlled pace. The ECB finally launched an aggressive QE program to get the eurozone back on track, and it in turn has accelerated the USD’s appreciation.
A weak dollar was an important component of the U.S. economic revival as it reduced imports while giving American goods a competitive advantage overseas. Given the policy measures of central banks in Europe, Canada, China and Japan to increase the supply of their home currencies to escape deflation, the U.S. might in fact end up importing that inflation as the USD further appreciates. That would serve to complicate the Fed’s decision on when to raise rates.
Consensus on Rate-Hike Timing Remains to Be Seen
San Francisco Federal Reserve President John Williams mentioned that although there is no rush to raise rates, a low inflationary environment is also not a reason enough to delay a hike if all other factors justify it. The Fed is not unanimous in its desire to raise rates. A known dove, Narayana Kocherlakota, has issued statements about the need to continue to stimulate the economy as employment is still weaker than hoped, and he fears a rate hike could jeopardize continued growth. The president of the Federal Reserve Bank of Minneapolis is not a Federal Open Market Committee (FOMC) voting member, but his dovish views highlights the divided opinions within the Fed.
So far the Fed’s “patient”; approach has helped it avoid the scathing criticism lobbed at Governor Mark Carney at the Bank of England (BoE). Carney’s optimistic rate-hike comments last year were quickly reversed after economic reality returned to the United Kingdom. British politician Pat McFadden called him an “unreliable boyfriend”; for this quick change of mind. The BoE has not fully regained the trust of the markets after its untimely diagnosis first of the recovery, and now because of a rushed estimate of the recovery that did not survive the headwinds from macro events.
Analysts are not expecting a change in the Fed’s policy when the FOMC makes its statement on Wednesday. The Fed can afford to be patient, and with no press conference scheduled, there will be no chance for the market to gain insights on Yellen’s thinking as to how developing global macro events will shape the central bank’s actions in the future. American policymakers are divided on the tightening schedule, but are united around the growth of the economy which is why some do not wish to risk derailing it, while others are sure the economy will thrive. Given the number of surprise central bank announcements in the past three months, the FOMC’s statement will be anticlimactic as the market has begun to push the first rate hike further past summer and into fall of this year.
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