What if the ECB cuts interest-rates will the US Fed then raise them?

One of the themes of these times has been the concept of “currency wars” as various nations and currency blocs have sought to gain a competitive advantage. However yesterday evening and this morning have reminded us of the fact that we are being promised interest-rate wars in December. Last night saw the Vice Chair of the US Federal Reserve Stanley Fischer pump out the party line and indulge in some Open Mouth Operations on the subject of an interest-rate rise.

we have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to “just do it.”

Well this first bit is untrue as of course many people ( but not us) have been surprised by the fact that the Federal Reserve has not already raised interest-rates this year. Also “when we move” is intriguing for an institution where only one member has voted that way so far and nine including Stanley voted for unchanged. Perhaps Jeffrey Lacker is the persuasive sort. Thus we are left with Yazz on the prospects for interest-rates.

The only way is up, baby
For you and me now

However there was more and Bank of England watchers may have noted the use of the plural here.

What lies ahead? In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates.

No doubt he does speak to Bank of England Governor Mark Carney regularly although he may not be fully away of his propensity for “spinning around” and his own version of Open Mouth Operations.

The Mario Draghi version

Rather intriguingly ECB President Draghi has latched onto the the Fischer theme last night and decided he is in complete agreement with “begin gradually moving away from near-zero interest rates.” So let us examine the speech to to the European Banking Congress he has just given.

The level of the deposit facility rate can also empower the transmission of APP (Asset Purchase Program or QE), not least by increasing the velocity of circulation of bank reserves.

So he is signalling a likely change but whilst he is moving away from zero and thereby agreeing with Stanley Fischer I am afraid that he is singing along with the Monkees.

Goin’ down. Goin’ down.

If we look at the stream of hints that President Draghi has given us in recent weeks then initial thoughts of a cut to -0.3% are being replaced by thoughts of a cut to 0.4%. The German bond market seems to humming that tune now. From @FerroTV

German 2year yield drops to a fresh record low

That is -0.39% now we see a theme of this blog, that negative interest-rates are on the march, increasingly comes to fruition.

Although it is hard not to smile as a past version of Forward Guidance implodes. At the European Banking Congress last year Mario told us this and the emphasis is mine.

The first step, as I said, was to lower overnight interest rates all the way to their effective lower bound – including below zero for the deposit facility.

What a difference a year makes! Are we now going to their ineffective lower bound?

Mario will have some “friends”

Such interest-rate hints from the ECB will put scowls on the face of a few central banks around Europe. A picture of his face is likely to go back on the dartboards of Sweden’s Riksbank, Denmarks Nationalbanken, and the Swiss National Bank as they mull having to cut interest-rates from -0.35% for the former and -0.75% for the latter two. Will we see someone cut to -1%?

Of course some of that is speculation but I doubt that many requests for leave on December the 3rd will be entertained at any of those institutions. It seems set to be a time for all hands on deck.

What else does Mario have in his locker?

One area where the ECB has been fairly consistent has been in its mantra that it can adjust its QE or APP program.

We consider the asset purchase programme to be a powerful and flexible instrument, as it can be adjusted in terms of size, composition or duration to achieve a more expansionary stance.

As we see more and more central bankers jawboning on the subject of market liquidity it is the size of QE that is the hardest to change on any large scale. Of course changing what is bought would be a help in that as for example Portugal has lots of debt the ECB could buy. But buying ever more government bonds would make those markets ever more illiquid and ever harder to shrug off protests that the lack of liquidity is caused by the same central bankers who pontificate on it. Accordingly an increase in the duration of the program seems likeliest to me beyond September 2016  as we mull the thoughts of a famous cartoon character.

On that subject you may be intrigued to note that the US Treasury Bond market seems to be setting itself for an interest-rate rise followed by QE 5 rolling down the slipway.

What else does Mario think?

The first message is a bit of back slapping and trumpet blowing.

Our measures have therefore clearly worked – in fact, they are probably the dominant force spurring the recovery that we see today.

So much for the falls in the price of oil and other commodities then. But Mario was determined to mine the same vein.

To give you a comparison, we estimate that in normal times our policy rate has to be instantaneously reduced by 100 basis points to see a similar impact on lending rates after such a short time period.

But more needs to be done and after all the hype comes a contradiction.

the present upswing which started in 2013 is the weakest euro area rebound since 1998.

Also we need to recall that the ECB is a central bank which prioritises its inflation target above all else.

The so-called core measures of inflation – which strip out volatile components – have also been drifting down since mid-2012 when the euro crisis hit its climax, and have been hovering around 1% for nearly two years………….Low core inflation is not something we can be relaxed about, as it has in the past been a good forecaster for where inflation will stabilise in the medium-term.

So at the cost of directly contradicting his predecessor Jean Clause Trichet Mario Draghi could not be clearer about his plans for December. Also by implication he is contradicting the words of Bank of England Governor Mark Carney when he told us that central banks do not make up their minds before policy meetings.


We have a potential clash of the titans on its way and of the two the likeliest move remains that of the ECB. After all it has backed up its rhetoric and promises with action whereas the US Federal Reserve has so far backed up its promises with more promises.  Also even the US central bank which is often insular may note the strength of the US Dollar.

Of course the ECB has the benefit of having the first move in the chess game as it meets a fortnight or so ahead of the US Federal Reserve. That might be a long time for the Fed to twiddle its thumbs for although they could spend it trying to find out where the interest-rate rise button is.

Ironically such prospects reverse what happened in 2011 when the ECB raised its policy interest-rate twice (to 0.75%) whilst the US was busying itself with QE 2 and then Operation Twist. What happened next? Well remind yourself of the current ECB interest-rate…

Meanwhile the two central banks must be singing this Diana Ross song to the other.

Upside down
Boy (Girl), you turn me
Inside out
And round and round
Upside down
Boy (Girl), you turn me
Inside out
And round and round



36 thoughts on “What if the ECB cuts interest-rates will the US Fed then raise them?

  1. Hi Shaun.
    Intriguing piece.
    US seems to have all the domestic bases covered for a rate rise, so if December’s meeting of the fed votes for continuation of present rates, it looks to an untrained eye like that would be more about concern for economies abroad.
    If we do get a normalisation of US interest rates, I think Europe has had it.
    Money-men will ask, “Why no response from Europe?” and their money will head west if they don’t get a satisfying response.
    I can see Europe having to double/treble its easing program, just to stand still.
    A bubble with a hole in it is no longer a bubble.

    • Dead right! The problem Europe has is that they are in a weak position with few options open to them, whereas the US is relatively strong and can almost do what it likes. Europe beware.

    • Shaun also made a point during a discussion last week that the USA isn’t as trade focused as much of Europe given it’s internal market and thus the implications to emerging markets of a Fed rate rise are a small consideration and not one that would stop them raising.The reality is that the implications for countries with large dollar denominated debts are huge-South Africa is a case in point I believe.

      ‘If we do get a normalisation of US interest rates, I think Europe has had it.’

      Agreed RB.In a hole but still digging.

    • The Fed faces a potential problem in the form of the Kitchin Cycle (a stock building cycle) and the Juglar Cycle (a business investment cycle). Both are due to move into a down swing sometime in the period in 2015 – 2019.

      I expect the Kitchin Cycle to start falling next year and the Juglar may coincide but I think it unlikely.

      I am sure the Fed is aware of this and is looking for indicators of said reductions in the 2 cycles which would explain it’s hesitancy over interest rate rises as otherwise it’s main measures of employment and inflation are saying “raise” BUT, if it raises and the 2 cycles coincide and the likeliest year for them to coincide is 2016 then that will make an immense depression.

        • I don’t understand the relevance if the question but any way yes the Juglar cycle was identified in 1862, so 153 years ago and no the Kitchin cycle was identified in the 1920’s so a little over 90 years ago if that helps??

    • One other thing, US money supply growth has been collapsing the last few months pointing to zero growth in Q1 and extending into Q2 of 2016 notwithstanding any of my other points. I wouldn’t want to be on the Fed right now.

  2. I somehow suspect the Fed will defer this time and give a few more months cheap money to GS.

    Their room for manouvre is getting smaller with the approach of a presidential cycle though and I suspect the looming figure in the distance of a Trump candidacy will bring a fresh approach from the Fed.He is asking a lot of questions and isn’t afraid to speak his mind.I do wonder what effect that cycle will have on the fed?

    Interesting times

    • Hi Dutch

      Mario Draghi and the ECB also have the advantage of the first move (December 3rd) which means that the Fed may have to watch the US Dollar continue to rise. Also I suspect that the Fed has been mulling the fact that central banks which have raised interest-rates in the credit crunch era such as the ECB and Bank of Canada have ended up cutting them again. So whilst the US employment report we saw recently moved the data towards a rate rise I still have my doubts, partly because they seem to believe that jawboning or Open Mouth Operations does a lot of the work.

      • Shaun, wouldn’t those arguments imply that the fed should never do anything again, ever, and you may as well have the US $ shadow the € alla Denmark?

        • Hi therrawbuzzin

          In a way yes 😦 .But if we were to choose a place where the central bank would do nothing then it would be best if it was at what might be regarded a neutral level of interest-rates. The catch is that we no longer know where that is and may never have known!

          For choice I would say around 1.5% right now would at least have some sort of balance. Now can we cope with balance anymore after years of junkie style monetary policy?

  3. Hi Shaun

    Despite all the hype I remain unconvinced that the Fed will raise rates next month. Many of the indicators of the real US economy are softening quite quickly – some think they are already in recession – and for the Fed to tighten in these circumstances seems to me insane. If they do I think they will lose the 1% of credibility they have left when it becomes apparent quite soon what a misstep this was. However, I think this would be part of a piece for the Fed as they haven’t had a clue for quite some years.

    As for the ECB it is simply doubling down on absurd policies which are guaranteed to make the economic situation worse. If the printing press was the route to economic nirvana we’d have been there a long time ago. Draghi is a bit player in the black comedy (or perhaps tragedy) that is the Euro; as Shakespeare said: “full of sound and fury signifying nothing”.

    One does now wonder whether the events in Paris will cause the whole thing (the EU) to slowly implode in which case where does the excrescence that is the Euro stand?

    • Hi Bob J

      If we consider the Euro then it has been falling for a while now as Mario Draghi and the ECB push it lower. If he acts at the December meeting and it behaves like last time then it will fall for a bit then tread water. Such a move this time round could take it towards parity with the US Dollar just as the Fed makes its decision. Interesting times!

      On the same theme Mark Carney may be looking at an even stronger UK Pound in such an environment and it has been on a long rally to circa 1.43 in Euro terms as it is.

      The US also has the issue of industrial production which was revised down but even on the lower base is falling. Yes of course shale oil and gas is an influence but if they rise and a strong dollar pushes it lower? So I agree it is much less of a done deal that we are being told.

      • Isn’t it the case that although quite strong, the dollar isn’t really forging ahead against most currencies other than the €, and, as such, trade levels may be seen in the Fed as trivial in this decision?

  4. http://www2.politicalbetting.com/index.php/archives/2015/11/17/the-gop-nomination-race-unless-the-mainstream-politicians-make-inroads-soon-trump-could-become-unassailable/

    ‘The GOP nomination race: Unless the mainstream politicians make inroads soon Trump could become unassailable
    Above is the latest Real Clear Politics Polling Average and the big story remains. None of the mainstream politicians have managed to gain real traction while Trump remains very strong.

    The latest average probably overstates Carson who had a troubled start to November which is starting to be picked up in the state polls. A new survey for the first full primary state, New Hampshire, has Carson in sharp reverse with Trump 22% ahead of the former neuro-surgeon with an interesting back story

    Because of the presence of Trump as a contender there’s been much more public interest in the race than we usually see at this stage. The GOP TV debates have been attracting record audiences and the campaign is getting more media attention. ‘

  5. The ECB totally failed to deal with house price booms in Spain, Ireland and the Netherlands. It’s mission to set eurozone interest rates is pie in the sky given the massively different economic conditions across countries affected by it’s rate setting decisions. The participants can break Euro Treaties with impunity.

    Given this unworkable foundation and euro-committee structure, it is a surprise that the ECB and Euro work at all.

    • Hi ExpatInBG

      Well it does work for the Euro area establishment who provide ever more jobs for themselves as the rise to 5 Presidents indicated earlier this year. Even those lower down the scale are about to get a backdated 2.4% pay rise which erodes the two year freeze.

      Eurostat has had a go at dealing with future asset price booms with its effort to put house prices in CPIH although so far the addition of other factors in it have weakened it if the UK experience is any guide and some European countries do not have data to calculate it. Still we do our best here as it may be that the only people chasing the UK ONS on the subject and pointing out the issues are myself and Andrew Baldwin

      • Yes, you do great work trying to hold the ONS accountable. Well done !

        Euro bureaucracy is too costly and wasteful. How they get away with increases given the dire state of govt finances in many member states is incredible. Even booming Germany has a deficit and excessively high debt to GDP. The EC’s pay raises whilst they preach austerity are preposterous, hypocritical. The reply to “let them eat cake” is “où est que guillotine ?”

      • Hodges point is that older cohorts consume less, regardless of assets and income: consumption is to a certain extent a function of age as well as income and assets. It is his contention that demographics will materially affect the economy in coming years and reduce the component of aggregate demand that is consumption.

        • Yes, I’ve heard this argument many times before but cannot reconcile it with the fact that as people age their consumption changes from consumer products(TV’s, computers, cars etc) to healthcare (drugs, vaccines, limb replacements and paid caregivers etc). It is my counter contention that they spend as much as ever, simply on different goods and services.

        • Sorry, I didn’t make the point properly which is thataggregate demand remains the same even though consumption falls. It is for private and public sector to re-calibrate their effrts and move away fromconsumption output proportionately with the changing demands of an ageing population.

          One final thought is that the reducing consumption argument is predicated upon the assumption that there is no immigration of younger workers. If this happens which it does to a small extent in the UK (although the current government has plan’s afoot to stop it – perhaps they want to engage in structural destruction of the economy?) the argument fails.

        • No. If you have an income of £50K in and spend 80% you will spend £40K. If in retirement your income is £20K and you spend 80% you spend £16K. You cannot spend £40K unless you go into debt or draw on assets.

          You are talking about substitution but if your income is lower this is irrelevant; you still won’t spend up to your working income.

          Also aggregate demand may not be the same; ceteris paribus it will fall and there is no automatic mechanism by which it can be maintained. This was one of Keynes’ central arguments.

          The only way the immigration argument would work is if the population structure in terms of age was unchanged and I suspect that might require very high levels of immigration. In view of recent events I think this unlikely.

        • I agree your last point re immigration but substitution holds – demand is demand.and the shortfall in income is made up via expenditure of savings and assets following sale

          It already happens when the elderly go into a care home. If you are looking at the long term and I mean the REALLY LONG TERM (when we are all dead to quote Keynes) then capital expenditure via savings and assets is unsustainable but it must be remembered that the elderly of today are replaced tomorrow by those whom are middle aged today, bringing their own savings and assets with them.

          I have seen your posts on surplusenergy where Tim essentially argues that in a World of finite resources the human race must die out and I agree.

          I disagree the time scale which most on that forum and some here seem to think is in the next few years.

          I think that we are effectively arguing about when things will fail rather than if, as, even in my immigration argument, one country’s immigration is another’s emigration thereby storing up potential new demographic problems in the donor country unless it has a high birth rate, which brings it’s own problems 60 odd years later requiring countries to have ever increasing birth rates to maintain the status quo. .

        • Noo2Economics.
          3 points.
          1) Wouldn’t you agree that the liquidity of people’s assets is a vital component in their consumption?
          2) Wouldn’t you also agree that older people’s wish to leave to their children makes them more frugal?
          3) Wouldn’t you agree that older people, “Don’t want to be a nuisance” to services and use them to the bare minimum, caring for each other?

        • I doubt that, on aggregate, people would replace lost income with a rundown of savings 100%; there is on balance likely to be a reduction in spending compared to when working. Although some, like Milton Friedman with his “Permanent Income Hypothesis”, postulated something like you are suggesting I’m not sure he meant this as persisting throughout the life cycle.

          Your point about replacement of the old by today’s middle aged is wrong and this is the nub of the argument. Hodges point is that there is a “bulge” which is not replaced and that is why as this bulge works its way through time that this situation occurs. The birthrate fell after the bulge.

          I wouldn’t say that things will necessarily “fail” but I do believe that we are going to need a larger “reset” in coming years than many realise due to these and other issues.

    • Hi Bob, it’s been interesting but time to come to an end, We are in disagreement on the rundown of savings, we actually agree about replacement of old by middle aged as I did mention immigration being a possible solution but that:

      ” ….If this happens which it does to a small extent in the UK (although the current government has plan’s afoot to stop it – perhaps they want to engage in structural destruction of the economy?)….”

      My point being that the UK Government are standing in the way of a possible medium term solution to which I went on to say:

      “… one country’s immigration is another’s emigration thereby storing up potential new demographic problems in the donor country unless it has a high birth rate, which brings it’s own problems 60 odd years later requiring countries to have ever increasing birth rates to maintain the status quo. .” i.e. if immigration doesn’t happen the vacuum behind the bulge cannot be ameliorated and even if it was that would require donor countries to have ever increasing birth rates to compensate which is clearly unsustainable for the donor countries

      Finally, we disagree on things failing – they will, we have infinite wants and as we live longer into old age and medical interventions save the disabled of any age , increasing age and disability related needs, but we live on a planet with finite resources. I believe the failure will be decades into the future, long after you and I have vacated this planet.

      It can be delayed a long time via a higher birth rate in the West and Japan resulting in population replacement but not expansion.

  6. Is it impossible that the Fed may raise by 0.25%, just to give the impression that the “emergency” is coming to an end, if it believes that it will do no real harm?
    Wouldn’t the Fed also like an end to newspaper headlines which say, “Unchanged for ….. years?”
    Hoping that both become a self-fulfilling prophecy?

    • Sorry, wrong button.
      To finish my above post, I think that the Fed will raise rates as soon as it dares, rather than wait until it is absolutely safe, for a couple of reasons.
      1) A lot of the problem of the past seven years has been confidence.
      2) Raising rates gives the Fed some lee-way when the downturn inevitably does come.

      As someone totally uneducated in economics (so no worse than many in the mainstream who are) I think the Fed will raise rates in December or January unless there is real trouble in the meantime.

      • Hi therrawbuzzin, this is a response to your post on my posts about people spending as much in retirement as they do when still working, so in answer to your questions:

        1. Yes and there’s nothing more liquid than cash savings and collective investments like Open Ended Investment companies, Investment Trusts and Unit Trusts. More recently, the Government has recognised another source of potential income for the retired to spend – their pension pots, hence the de-regulation (which I agree with – the de-regulation that is, not necessarily the way people spend those realised pension savings). As an aside I think the Government hopes people fall foul of tax law withdrawing too much from their pots, inadvertently landing themselves with a large tax bill. People still use Equity Release schemes to unlock the cash from their homes, which is something else I disagree with but here I am simply saying what others do not whether I agree with those actions.

        2. Yes….and ….No. Many do want to look after their children’s long term security after they have died but find themselves overtaken by events if/when they become very ill and go into a home or have carers coming into their home to look after them, following a care needs assessment and financial assessment where they are told if they have more than about £23000.00 in savings they have to pay the full cost of care whilst a tapered charge is made if they have less than £23000.00 and if they are alone (their partner is no longer around in the home and they have no other relatives over 60 or under 16 or who are in receipt of certain disability benefits living in their home) their house will be counted as part of their assets and basically “claimed” by Social Services who will either sell it or put other people in need of Social Services help in it and charge them a rent. So the assets are lost to the State.

        Others adopt a spend spend spend attitude with no thought to their children whilst others are disappointed in their children and consciously exclude them. Of course, if children, relatives, friends and neighbours rally round this could be avoided but I rarely see that happen,

        3. Depends what you mean by “older”. Yes if you’re talking about people over about 75 – they are from the old stoical generation of make do and mend and grew up with a very “small State” in terms of assistance viewing welfare benefits and help as “charity” to which they attach a stigma, but that age group is dying out.

        No, if you’re talking about people under 75 who grew up with a bigger “State” which has gradually grown as time has gone on and they view benefits and help as a right.

        If you read back through my posts on this subject you will see that my comments are that peoples expenditure pattern changes but remains at the same volume, what I didn’t say is that it can in fact increase as they require more medical care which is funded initially by their savings and assets (including in most cases their homes with the exceptions mentioned at #2 above), thereafter the State shoulders the expenditure (assuming they have not died), although it also automatically shoulders extra expenditure as they grow more infirm, requiring prescriptions (free) mobility aids (free on the NHS, of course it isn’t “free” as we have all prepaid for it via our NI conts but the Govt squandered those on bailing out the banks etc) ) and medical and in some cases surgical interventions (free on the NHS) resulting in the same or greater aggregate expenditure either in private or public sector but as I said to Bob J demand is demand whatever it’s composition.

        • One other thing – if Hodges is right in his erroneous argument that the older groups spend less as their income is less (which frankly is a very naive view of spending patterns) this would therefore logically mean that the savings and assets of the older groups which according to Hodges and Bob J will not be spent, or at least not much of them will be spent, will be passed on to their children, who will spend it or pass some or all of it onto their children (the grandchildren) who will spend it, unless the continued fantasy is that those children (not the grand children) will be in the old age group by the time they inherit and simply pass on their inheritance along with their own savings to their children upon their death adinfinitum leading to immense capital holdings but low income. Human nature being what it is, it is impossible that this would happen in the populace as a whole although there may be isolated cases where that happens.

        • N2E: Thank you for your full and studied reply.
          I’m not sure I agree with all of it, in fact, I’m sure that there are parts I would take issue with, (use of liquid assets for indirect consumption, or indeed investment, depending on how you view home purchase, most notably, helping offspring onto the housing “ladder”, which makes their assets far less liquid) but it is a very interesting argument, well made.

    • Thanks – it’s not about agreement to me, it’s about exchange and sharing of ideas to be locked away, remembered and considered when being exposed to other ideas/ideas developed from things you’ve already read about.

      Hopefully we can arrive at a better understanding of the world we live in, how we relate to it and how it relates to us. I am not in the business of trying to find agreement with my ideas and views, that’s too much like domination and power seeking and any way my ideas keep changing as I am exposed to more views and ideas and no I am not Mark Carney hiding behind a pseudonym! I am an anarchist refugee from ’77.

      • I’m similar, but at a far less advanced stage.
        My opinions are based largely on what I’ve seen, both in my small World and UK political sphere.
        Even still, I think my opinion may be worth something, as people are people, and even if they’re not, we learn from mistakes, not so much from being right.
        Shaun and many of the commenters on here have taught me such a lot.

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