A tale of two markets: Interest rates rise in U.S., hold steady in Eurozone

On the latest edition of Market Week in Review, Consulting Director Sophie Antal Gilbert chatted with Chief Investment Strategist Erik Ristuben about the U.S. Federal Reserve (the Fed)’s recent hike in interest rates, the European Central Bank (ECB)’s decision to keep its rates unchanged and the progression of tax reform efforts in the U.S.

Fed raises rates despite sluggish inflation data

Amidst the backdrop of a healthy U.S. economy, the Fed decided to hike interest rates on Dec. 13, Ristuben said—increasing its target policy rate to a new range of 1.25-1.50%. However, he noted that the same day, new inflation data released by the U.S. Department of Labor showed a slowdown from the previous month, with core inflation for November dipping to 1.7% year-over-year—down from 1.8% in October, and short of the Fed’s stated goal of 2%. So, why the hike? “The Fed is likely of the mindset that wage pressure will start moving up in 2018, which they think will lead to an uptick in inflation,” Ristuben explained, adding that the Fed probably views the sluggish inflation numbers as transitory.

He and the team of Russell Investments strategists believe that the Fed will probably raise interest rates three times next year—slightly less than the central bank’s original vision, first laid out in 2015, of four tightenings a year. “Given the soft patch in inflation, we’re of the opinion that four hikes would be a little too ambitious for 2018,” he concluded.

Steady as she goes: ECB leaves interest rates unchanged

Turning to Europe, Ristuben noted that the ECB held off on any interest rate increases at its Dec. 14 meeting. The bank’s decision is largely reflective of the fact that Europe is further behind in its market cycle than the U.S., Ristuben said. “As proof, for one of the first times, ECB President Mario Draghi used the word expansion—instead of recovery—when describing the eurozone economy,” he said. Ristuben added that Draghi’s remarks also made it clear that the central bank doesn’t see the region’s economic expansion as self-sustaining enough to generate inflation.

“In a nutshell, the ECB wants to continue to stimulate the economy until inflation can rise to 2%,” Ristuben said—“and until that happens, we expect them to continue on with an accommodative monetary policy.”

Tax reform update: A new law by 2018?

The U.S. Congress continues to make headway on a sweeping overhaul to the nation’s tax code, Ristuben said—as Republican leaders in both chambers agreed on a joint bill on Dec. 14. “The measure that’s been put forward is bigger than what we thought they’d initially get done—so if it passes, it’ll likely be fairly stimulative for the economy,” he said. However, Ristuben added, it’s still unclear if the Republican party will have enough votes to approve the bill, especially in the Senate. “Republicans pretty much have to get tax reform pushed through next week,” he stated, “otherwise, they’ll face an even narrower majority come January as Doug Jones (D-AL) replaces Luther Strange (R-AL) in the Senate.”

The potential new bill is coming at a very interesting time, Ristuben added, given that the U.S. economy is likely in the late stages of the market cycle. “We usually don’t see this much fiscal stimulus at this point in time,” he said—noting that the overall situation is made even more unique by the fact that the Fed is concurrently tightening monetary policy by raising rates.

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