It’s that time of month again—when the Federal Open Market Committee releases the minutes to its latest policy-setting meeting. This is typically a market-moving event because it reveals the Fed’s outlook for the economy, and what policies the Fed will pursue to encourage growth. Now that Quantitative Easing has officially come to a close, the Fed’s focus has shifted outside U.S. borders towards what the world’s other central banks are up to.
Before I get into the recent minutes, let’s review what has been going on around the world.
The 18-country Eurozone saw Gross Domestic Product (GDP) increase at a 0.6% annual pace in the third quarter. Surprisingly, the fastest growing economy in the Eurozone was Greece, which grew at a 2.8% annual pace. Another bright spot was Spain, which grew at a 2% annual pace. France grew at a 1.1% annualized pace, while mighty Germany only grew at a 0.3% annual pace. Italy’s GDP actually contracted at a 0.4% annual pace in the third quarter.
In response to this, the European Central Bank (ECB) announced that it would not hesitate to resort to unconventional measures, including full-blown quantitative easing, to help revive the Eurozone economy. Specifically, after the ECB’s monthly meeting, ECB President Mario Draghi said during a press conference that its asset purchases might return to levels not seen since the beginning of 2012. Draghi’s comments essentially spooked currency traders and sent the euro tumbling to a 26-month low against the dollar.
Overall, the Eurozone is not slipping into a recession; in fact, I expect the area’s exports to rise in the fourth quarter. A weak Euro is making many Eurozone countries more competitive on the world stage.
Now, here’s why what is happening in the European Union is so important. The bottom line is that the ECB has pumped so much money into its banking system that its member banks are fleeing to the U.S. in search of a stronger currency and higher real interest rates. This in turn is undermining our Fed’s ability to manipulate interest rates. As a result, this “euro glut” is now squelching interest rates globally and raising the risk of deflation, especially in countries with strong currencies, like the U.S.
With deflation risk mounting, there is little chance that the Fed will be raising key interest rates for the foreseeable future. Which brings me back to today’s FOMC minutes, which have two key takeaways. First, regardless of the impact of the weak Euro and Japan’s recession, the Fed isn’t concerned of a weakening global economy. Even with some global economies slowing down, the Fed expects that the U.S. will be insulated against these problems. Second, nearly all of the FOMC members voted to maintain the language that interest rates would be kept low for a “considerable time” after the end of QE.
While the stock market yawned at the FOMC minutes, this is great news. The beneficiary of the low interest rate environment is clearly the stock market, because it enables companies to borrow at ultra-low rates all over the world and use the proceeds to aggressively buy back their stock. This further boosts companies’ underlying earnings per share and keeps liquidity in the market.