In the past eight weeks, we have seen a tidal wave of accommodative global monetary policy develop at least partially under-the-radar, and how the Fed will react is still up for debate.
So far in 2015:
Taken in totality, all of this stuff is remarkably dovish, effecting loose policy for every member of the G10 except for the US. The reasons for this re-invigoration of globally easy monetary policy (whether that’s deflation risk and sluggish growth across Europe and Japan, falling commodity prices for commodity-export economies, or pockets of persistent unemployment) are all interrelated through global trade, labor, and capital flows. Several of the actions above could be considered “copycat” cuts following the big boys, but the result is that global financial markets are still simmering in a stew of astonishingly loose monetary policy.
The dogmatic rhetoric out of the Fed in recent months stands out in stark contrast to the central banks in the rest of the developed world (and much of EM as well). It is certainly true that the economic health of the US is now far superior to much of the rest of the world, but the US does not exist in a vacuum. The Fed has chosen however to carve out a narrow focus, concentrating on pent up wage inflation as the impetus for their planned mid-year rate hike. While it’s true that the unemployment rate appears to be approaching the level at which wage inflation should present itself, there are new external factors at play which have given the Fed some “outs” that they so far have not chosen to take.
In recent posts I’ve discussed plummeting inflation due to energy prices and the de facto tightening which has already occurred to real policy rates as a result (see A Slight Disagreement). Today I want to reiterate the effects of the nine ingredients listed above: every “other” currency of the G10 is being intentionally weakened by each respective central bank, in order to ward off deflation and perhaps induce some nominal growth. The strength of the dollar, which has directly resulted from the divergent stance of the Fed, is an important driver of the significantly tighter financial conditions cited by my colleague Brandon Merrill in his post last week (chart). For good reason: strong currencies ought to be anti-inflationary all else equal, in just the same way weak ones are the opposite. For the US to tighten policy in the face of a chain-reaction of monetary easing elsewhere, when such a move is not absolutely required by imminent and problematic inflationary pressure, risks absorbing the deflation that other economies are seeking to fight off.