Clouds Over US Outlook, Sunshine In Europe

dollar deppreciation against eurodollar deppreciation against euro

While the euro area managed to sustain its upbeat momentum over the summer months , market doubts about the trajectory of the US recovery have started to deepen. As economic growth becomes less dependent on accommodative monetary policy, markets are increasingly focusing on politics and the ability of governments to implement fiscal and structural reforms. On this metric, the euro area, led by two centrist – policy makers with an appetite for reform is faring far better than the US, where to date politic al manoeuvring has appeared pretty powerless.

Indeed, in the US, sentiment towards politics and policy has deteriorated as a result of escalating tensions with North Korea and poor cooperation between the White House and Congress.

AXA IM now expect minimal or no fiscal stimulus. Furthermore they scale down their expectation for further Fed policy normalisation and expect only three more hikes by end -2018, respectively in December 2017, March and June 2018. Before that, the Fed looks set to announce the unwinding of its balance sheet at its September meeting.

For Europe, with economic momentum brisker and inflation on track, the ECB should start tapering from January 2018. However , the strength of the euro will likely weigh on the design of the tapering decision. In AXA experts’ view, the ECB will strive to provide the most dovish tapering possible and lead markets to believe it is standing ready on the side-lines, to purchase and expand its balance sheet by as much as necessary, to avoid excessive tightening of financial conditions as the euro remains strong or continues to appreciate.

Therefore, in September, we expect no hard decision but the staff forecast is likely to trim inflation projections a little to reflect new FX assumptions. Looking ahead, it is really in October that we expect the ECB to prove creative once again and to deliver tapering while mitigating its hawkish tendencies in order to cap the currency appreciation.

Furthermore, it will play with the many available options, including the timing of the decision, the amount of purchases, the duration commitment of purchases and the forward guidance on short -term interest rates.

Changes in the nature of purchases look less likely in our view, given the limited room for manoeuvre under scarcity. Overall, while we expect the October meeting will specify that some tapering will start in the first quarter of 2018, it should leave enough margin for any subsequent uncer tainty.

This gap between US and the Eurozone has been reflected in the sharp depreciation of the dollar against the euro and other currencies.

We do not expect this trend to reverse anytime soon and believe monetary policy is likely to continue to have little role to play. It seems that only a renewed bout of US economic policy action would be able to buck this trend. This environment has profound implications for markets – we now expect little movement in the US curve until year -end, and only very measured ones in Europe, as the European Central Bank (ECB) strives to implement as dovish a tapering pattern as possible, which leads us to believe that equities should fare better in Europe than in the US.