You say goodbye, and I say hello
- To paraphrase the Beatles, in 2019 the Fed may say "goodbye" as the ECB says "hello" to rate rises. US policy rates have risen 2% since 2015. The Federal Reserve should raise rates next week. But with the federal funds rate at 2.5%, US interest rates look more "normal." Most estimates have normal fed funds between 2.5% and 3.5%. The Fed is likely to add another two rate hikes in 2019, if its inflation measure is around 2%. After that, a pause may be justified.
- US quantitative policy will still tighten. The Fed's balance sheet (a proxy for money supply) is falling in dollar terms. It is falling even faster relative to GDP (a proxy for money demand).
- The European Central Bank is just starting. Its balance sheet is shrinking as a share of GDP already. This will speed up as the ECB stops buying new bonds from 2019. At the end of 2019, the ECB may increase interest rates.
- Four years between US and European rate increases is no surprise. The US economy recovered before Europe. US policy had to tighten before Europe. US and European policy should not be judged against one another. Policy should be judged against the needs of the two different economies.