[01/23/15] The European Central Bank’s launch of an aggressive program this week to buy more than €1 trillion in bonds poses important tests for the U.S. economy and the Federal Reserve.
Europe’s new program of money printing—and the resulting fall in the euro—means the U.S. economy must deal with a rapidly strengthening dollar that will make American goods more expensive abroad.
The stronger dollar could slow both U.S. growth and inflation, giving the Fed some incentive to hold off on its plan to raise short-term interest rates later this year from near zero.
U.S. officials have been playing down that scenario, and, more broadly, resisting talk of a global currency war—competitive devaluations by countries eager to keep their currencies as low as possible to protect exports.
The U.S. dollar has already soared in the wake of the ECB announcement Thursday to launch a €60 billion-a-month bond-purchase program, known as quantitative easing or QE. That program will flood the eurozone’s financial system with euros created by the central bank to buy government and private sector bonds. That is expected to boost growth by making eurozone goods and services cheaper around the globe.
The dollar has already gained 15% against the currencies of U.S. trade partners in the past year. Among the factors driving the rise has been the U.S. economy’s strong performance amid a slowing global economy, as well as Fed signals of a likely rise in interest rates this year.
A stronger dollar has three important implications for the U.S. economy, markets and policy makers. First, it tamps down inflation just as the Fed is trying to raise inflation closer to 2%. Second, it hurts exports and therefore economic growth. Lastly, the attraction of U.S. financial assets could heat up markets just as regulators keep watch for dangerous asset bubbles.
The U.S. isn’t in a position to serve as the world’s economic engine—as it did in past periods such as the late 1990s—having struggled to breach 3% growth rates since the end of recession in mid-2009.
“The Fed faces a challenge having to navigate some pretty intense cross currents,” said Bruce Kasman, chief economist for J.P. MorganChase.
Mr. Kasman said he worried most about the effect on inflation. U.S. consumer price inflation has run below the Fed’s 2% target for 31 straight months. Prices were up just 1.2% in November from a year before, according to the Fed’s preferred measure.
J.P. Morgan analysts believe the stronger dollar has become an increasingly important factor. The bank estimates prices for U.S. imported consumer goods were down 1.7% in January from a year earlier, a move its analysts said was closely associated with the stronger currency, which holds down the price of imports.
The U.S., in effect, is importing some of the world’s downward inflation pressure through currency movements.
J.P. Morgan projects the Fed will raise U.S. short-term interest rates in June, but Mr. Kasman said he was wavering because of the latest downward pressure on inflation. “It’s a tough call right now,” he said.
Fed officials say they aren’t too worried about the effects of a stronger dollar on broader economic growth, at least for now.
Exports account for only 13% of U.S. economic output. Even though a strong dollar weighs on exports, the broader economic impact is limited. Moreover, it could be offset by benefits to American consumers from falling oil prices.
Many U.S. officials privately say they prefer a strong European trade partner—even at the expense of some exports—to a weak Europe with associated risks to global growth and financial stability.
Analysts see other benefits to the ECB’s asset-purchase program. It will likely lower borrowing costs world-wide, said Kiran Ganesh, cross-asset strategist at UBS Wealth Management, which oversees $1 trillion in assets. Investors hunting better returns are drawn to U.S. Treasurys, reducing the cost of credit in the U.S., he said: “On an overall basis, ECB QE helps the U.S.”
Even if the Fed felt threatened by the ECB move, it would be hard for officials to push back hard against quantitative easing because they have supported the strategy in the U.S. and abroad.
“These policies are not ‘beggar-thy-neighbor’ but rather are positive-sum, ‘enrich-thy-neighbor’ actions,” then-Fed Chairman Ben Bernanke said in a speech at the London School of Economics in March 2013. At the time, the Fed had launched a third round of bond buying which pushed its portfolio of bonds, loans and other assets to nearly $4.5 trillion.
In November, speaking to French bankers in Paris, Fed Chairwoman Janet Yellen said, “Central banks need to be prepared to employ all available tools, including unconventional policies, to support economic growth and to reach their inflation targets.”
The Bank of Japan ramped up its own QE program in the fall, and the People’s Bank of China has eased credit in the face of slowing economic growth.
ECB officials have repeatedly said they don’t target the euro’s exchange rate when setting monetary policy. Still, policy makers in Europe have talked down the euro’s value since early last year, when the currency reached $1.40 against the U.S. dollar, a level that threatened to choke off exports as the eurozone struggled to recover from a pair of recessions.
“The main point here was influencing the exchange rate,” Austria’s central bank governor Ewald Nowotny said on an Austrian news show when the ECB cut interest rates in September and the euro was around $1.30. On Friday, the euro fell to $1.12 from a high last year of $1.39.
The euro’s decline gathered momentum through the fall as officials made it clear they were readying a substantial QE program.
Publisher: The Wall Street Journal
Authors: Mike Cherney, Brian Blackstone and James Ramage contributed to this article.
Link: http://www.wsj.com/articles/euros-big-drop-puts-u-s-economy-federal-reserve-to-the-test-1422059437
