Bank of the West US Outlook Report for January 23, 2015

  • by BPC Staff
  • on January 23, 2015

Bank of the West US Outlook Report for January 23, 2015 

After three rounds of quantitative easing, the Fed is remaining on the sidelines as global central banks from the ECB, Canada, Peru, Switzerland, Denmark and India all made moves this month to loosen monetary policy and head off economic and deflation risks.

The ECB’s launch of its own QE asset purchase program stole the headlines and will have the farthest reaching implications for the global economy, markets, and the United States.

My first observation of the ECB’s dramatic move is that the asset purchases of 60 billion euros per month starting in March, 1.1 trillion euros in total through September of 2016, are in the right ballpark to improve Europe’s economic and inflation outlook.  Initial market reactions from stocks, bonds, and the euro have been encouraging and will be a net positive for European growth prospects. But one of the most attractive features of asset purchase program is that it is open-ended should additional asset purchases be needed.

The drop in the euro is the most helpful outcome of this week’s market action. The euro dropped more than 2.0 percent on Thursday and has fallen 9.2 percent against the U.S. dollar since December 16, and 19 percent against the U.S. dollar since last March. A weaker euro will bolster Europe’s exports, tourism, and transportation industries, while helping to stabilize Eurozone prices.  It’s like a 20-percent-off coupon for foreign buyers of the Eurozone’s goods and services.  At the same time, a weaker euro blunts oil price declines in euros and will raise import prices on a whole range of other imported goods, getting the ECB closer to its goals on the economy and inflation. While not a complete panacea for what ails the Eurozone, the ECB’s QE is a significant step in the right direction.

From a U.S. perspective, the ECB’s actions take away the worst case economic and deflation scenario for the Eurozone.  By doing so, it reduces the risk of financial contagion from the Eurozone to the U.S., which solidifies our outlook for a relatively robust U.S. economy this year.

Finally, the ECB decision yesterday makes a Fed mid-2015 liftoff date for the Fed funds target rate more likely. With the ECB now more forcefully addressing deflation risks there, the Fed will feel less pressure to delay rate hikes in the United States.  This makes the Fed’s current short-term interest rate normalization plans more likely to be executed on time this year.  We still see the June FOMC meeting as the most likely date for Fed Funds target rate liftoff.

What could get the FOMC to hold its fire and delay liftoff this year?  Barring widespread financial crisis or a pull-back in wage growth, I have trouble seeing any.  Of particular interest this coming week will be the Employment Cost Index for the fourth quarter released next Friday.  This measure of labor market compensation has been trending higher over the past two quarters at its fastest clip since the first half of 2008. Any significant reversal in that positive trend, especially in light of the weaker-than-expected average hourly earnings growth in December’s payroll report, could give the members of the FOMC some more reasons to wait a while longer. But, even that scenario seems unlikely in my view.

To find out more, check out this week’s US Outlook Report.