Fed's pause becomes the ECB's problem

"Patient and flexible". These are the two words the US Federal Reserve has us mulling over with regards to the conduct of its monetary policy over the course of 2019.

How patient and flexible? The CME FedWatch Tool puts the probability of the fed funds rate remaining at the current 2.25%-2.50% level by 11 December 2019 meeting at 70.2% -- up from 41.7% a month earlier (prior to the Fed's 18-19 December 2018 FOMC meeting).

What's more, the likelihood of a rate cut at its 19 January meeting (based on fed funds futures trading) has increased to 17.7% (from 14.4% a month ago) while the chances of a rate hike to 2.50%-2.75% declined to 16.4% from 31.1%.

This brings good tidings to America and by extension, emerging markets, through its flow on effects on the US dollar (a weaker one).

However, a weakening US dollar will have to be reflected by strengthening in other major currencies, such as the euro.

The euro's 4.5% depreciation versus the greenback last year has allowed the European Central Bank to end its asset purchase programme at the end of 2018.

The euro's now appreciating as a result of the Fed's shift in stance. It has now risen by 1.8% since hitting an 18-month low last November.

Not good tidings for an economy that's already losing momentum. Not only has Eurozone GDP growth slowed to 1.6% in the third quarter of last year - the fourth straight quarter of slowdown - but forward indicators suggest more weakness.

Markit Economics' Eurozone composite PMI declined to a reading of 51.2 in December from 52.7 in  speed (50.0 level).

Similarly, the progress achieved with regards to inflation in late 2018 has reversed. Eurozone HICP inflation slowed to 1.6% in December 2018 from 1.9% in November and a peak of 2.2% in October. Core inflation remained at 1.0% after peaking at 1.1% in October.

Needless to say, the continued appreciation of the euro vis-a-vis Uncle Sam's currency would exacerbate the negative momentum with regards to the region's growth and inflation prospects (although this should be somewhat mitigated by the improved growth outlook in emerging markets resulting from US dollar weakness).

But have no fear, the European Central Bank (ECB) is very much aware of these new challenges just as the Fed. In the minutes of its 12-13 December 2018 Governing Council meeting, the ECB confirmed that, interest rates would remain at present levels "for as long as necessary to ensure the continued sustained convergence of inflation to levels below, but close to, 2% over the medium term" and that, it would "continue to reinvest, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date of a first increase in the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation".

Read more: FedECBEuropean Central BankUncle SamUS Federal ReserveEurozone GDPAmericaCME FedWatch ToolEurozone HICPFOMCGoverning CouncilMarkit EconomicsPMI
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