On Thursday, March 7, the markets heard from the President of the European Central Bank. Mario Draghi and the ECB have been far behind their counterparts at the US Federal Reserve. Quantitative easing in the US came to an end years ago, and the central bank has been reducing their swollen balance sheet since October 2017. In Europe, the QE program only ended in December 2018. The FOMC began tightening credit and raising the short-term Fed Funds rate in December 2015 and has already increased the rate to the 2.25-2.50 percent level with the latest rate hike of 25 basis points coming at their December 2018 meeting. The ECB has not touched short-term rates which continue to stand at the negative forty basis points level.
Europe followed the United States into a period of monetary policy accommodation following the 2008 global financial crisis. While the US shifted course in 2014 and 2015, Europe has not followed. The latest news from the ECB and its President told markets that they would need to continue to wait for anything other than accommodative monetary policy as the dovish orientation continued. The ECB rolled out a new program for lending historically cheap money as stimulus.
On March 7, the ECB downgraded their forecasts for economic growth in the Eurozone as they pushed GDP forecasts over the coming years lower. The ECB told markets that inflation remains well below their 2 percent target rate and that they will reinvest the proceeds of quantitative easing. In the US the legacy of QE has been rolling off the Fed’s balance sheet, but in Europe, the ECB appears to be nowhere near reducing theirs. The markets have been waiting for a sign that rates would begin to rise towards zero percent, but the latest news was a continuation of the same, there are no rate hikes on the horizon. Trade issues between the US and China and the US and other trading partners around the world including Europe were one of the factors mentioned by Mario Draghi as a root cause of sluggish economic growth, particularly in the German economy.
The dovish message from the ECB sent US stock prices lower on Thursday, and the dollar moved to the upside against the euro currency to just shy of the mid-December peak. One of the primary determinates of the path of least resistance of foreign exchange rates is interest rate differentials. With the US central bank on a path of tightening credit and a dovish ECB, the contrasting policies provide support for the dollar and weigh on the value of the euro. Since both the dollar and euro are reserve currencies, the euro makes up 57 percent of the dollar index which rallied in the aftermath of the ECB comments about their plans for monetary policy.
A stronger dollar weighed on many commodities and equity prices on Thursday. The European Central Bank continues to soar like a dove. On the other side of the Atlantic, even though the Fed has paused and taken a less hawkish approach to monetary policy so far in 2019, the contrast highlights the widening gap between US and European rates which favors the US currency at the expense of the euro. After all, the dollar offers yield and the potential for capital appreciation, while there is a cost to holding euros and ECB policy continues to weigh on its value against other world currency instruments.