While some market watchers have been speculating that the Federal Reserve (Fed) will raise the federal funds rate at its meeting this month, the central bank is more likely to do what it did in September: nothing.
The Fed’s continued delay has repercussions for more than just the U.S. economy and markets. I believe it’s also likely to lead to more stimulus from the European Central Bank (ECB) and Bank of Japan (BoJ), which may ultimately support the case for stocks in Europe and Japan.
To understand why this is the case, here’s a little primer on the typical relationship between Fed rate increases and the dollar. When the Fed raises rates, the prices of dollar-denominated assets like U.S. Treasuries generally drop, while their yields correspondingly rise. In response, both foreign and domestic investors have tended to flock to these dollar-denominated assets, increasing demand for dollars, and leading to a stronger dollar.
In contrast, after the Fed’s September meeting, where the rate was left unchanged, the dollar dropped, and foreign currencies strengthened against the greenback, according to data accessible via Bloomberg.
This isn’t the scenario that economies with weaker currencies typically want. They want a stronger U.S. dollar to help fuel their economies. When their currencies are weaker than the dollar, their countries’ goods are less expensive for foreign customers, fueling exports and economic growth.
So, given a Fed on hold, we could see other central banks, including the ECB and BoJ, augmenting their own monetary stimulus measures in order to weaken their currencies.
Easy Money and the Impact on Equities
The likelihood of continued easy money is one of the reasons I see a compelling case for considering exposure to stocks in Japan and Europe, and within Europe, to large exporter Germany in particular. It’s true, of course, that the ultimate path of monetary policy—and the dollar—remain uncertain. Yet after recent comments from Fed Chair Janet Yellen, I see the Fed raising rates by year’s end.
But regardless of when liftoff occurs, rates are likely to remain low in the U.S. for the foreseeable future. The Fed has made it clear that it will raise rates slowly and keep them low for longer, as it tries to normalize monetary policy without damaging the U.S. economic recovery.
Market Fundamentals in Japan and Germany
That said, even if future central bank policy moves surprise the market, equities in Japan and Europe (and particularly in Germany) look attractively valued following recent market volatility. In my opinion, stocks in these regions have sold off too much since the start of the summer, given fundamentals in both markets.
Exchange traded funds (ETFs) such as the iShares Currency Hedged MSCI Eurozone ETF (HEZU), the iShares Currency Hedged MSCI Germany ETF (HEWG) and the iShares MSCI Japan ETF (EWJ) can provide access to stocks in the eurozone, Germany and Japan, respectively.
