4 Ways Monetary Policy Could Boost The Global Economy

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by: Steady Investor

By Mitch Zacks

The largest central banks around the world are making moves - just not necessarily in the same direction. While the U.S. Federal Reserve is tightening credit, the European Central Bank (ECB) and the Bank of Japan (BOJ) are easing their monetary policies to stimulate their economies. With policymakers desperate to bolster their respective domestic economies, investors may be perplexed about the global implications. What are investor's to do? Here is Zacks Investment Management's perspective.

In their attempts to stimulate demand, Europe and Japan are pursuing aggressive expansionary policies. The ECB has been actively trying to combat Europe's sovereign debt crisis for a while now: it started its Quantitative Easing operations in March 2015 that involves €60bn worth of asset purchases per month. Further, in December, it announced plans to cut deposit rates (from -0.2% to -0.3%) along with extension of its QE program at least until March 2017. With current inflation of 0.2% and still a long way off from the target 2% level, the ECB is unlikely to budge from its stance.

Following in the footsteps of the ECB, Japan shocked markets recently as it unveiled a new interest rate regime that includes a negative interest rate (-0.1%) on banks' excess reserves held with the central bank. This comes after the BOJ's sizable bond buying program failed to achieve its target inflation rate of 2%.

In stark contrast to these stimulus measures, the U.S. Fed commenced a tightening cycle this past December with a 25 basis point hike in Fed Funds rate.

Divergent policy objectives between different economies have sparked fears about currency mismatches, among other things. Some are concerned that the higher interest rates in the U.S. will strengthen the greenback further, particularly when Japan and Europe are offering lower borrowing costs, and lead to reduced competitiveness of the U.S. in global markets for goods and services.

This could have a measurable impact moving forward. However, there are several other positive outcomes that divergent monetary policies could produce:

1) Cheaper Imports

As the U.S. dollar strengthens, relative to the currencies of trading partners, consumers and businesses benefit from cheaper imports. For the business sector, a stronger dollar would translate into lower production costs for several industries through cheaper imported inputs such as machinery and engines.

2) Easing Concerns over the Yield Curve

With global volatility and inflationary struggles around the world, it seems likely that the Fed will stay committed to its plan of gradually raising interest rates. That could mean skipping rate hikes at meetings over the course of the year, which means the short-end of the yield curve is likely to remain low all year.

3) Positive Spillover to the US

Policy rate cuts implemented by Europe and Japan could eventually benefit the U.S. economy. Increased liquidity abroad could result in more capital seeking risk assets, with U.S. stocks being a sound choice.

4) Promising Domestic Conditions

Easy monetary policy abroad should help those economies expand on the year, which should also support fundamental strengths already present in the U.S. Recent macroeconomic indicators underscore our underappreciated strength: for instance, The Chicago Purchasing Managers' Index read 55.6 for January, beating expectations of 45.3. Also, the sanguine prospects for the consumer sector, which accounts for about 70% of the nation's economy, were bolstered by wage improvements and jobs growth (12.5 million jobs added over the last 5 years) coupled with stronger discretionary spending.

Bottom Line for Investors

With expansionary monetary policies taking hold in Japan and Europe, should investors "follow the money" and reallocate portfolios away from the U.S.? Not necessarily, in our opinion. Policymakers abroad are adopting expansionary monetary policies to stoke growth and inflation, but the results are yet to be proven. We think it will work, but expectations are high, and if either region falls short, it could be a big negative for markets.

On the other hand, the U.S. already has strong fundamentals in place, which are only going to be buttressed by future global improvements. We think it makes more sense late in the cycle to stick largely with the best and most stable house on the street, the U.S.

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

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