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What Investors Should Know About Monetary Policy Divergence

Wells Fargo Investment Institute - May 2018

Recent economic improvement in Europe and Japan has sparked concern that central bankers in those regions will soon end accommodative monetary policy. Veronica Willis, Investment Strategy Analyst, discusses Wells Fargo Investment Institute’s global monetary policy expectations for the coming year—and what they may mean for investors.

Transcript: Monthly Investment Outlook:What Investors Should Know About Monetary Policy Divergence

Monthly Investment Outlook:What Investors Should Know About Monetary Policy Divergence
Presenter: Veronica Willis, Investment Strategy Analyst, Wells Fargo Investment Institute
Title graphic: What investors should know about monetary policy divergence
Recent economic improvement in Europe and Japan has sparked concern that central bankers in those regions will soon end accommodative monetary policy. Investors may be considering the impact of these potential changes on the global fixed income and equity markets.
Expectations that the European Central Bank and Bank of Japan monetary policy will converge with the U.S. Federal Reserve’s policy may have run ahead of actual central-bank action. And, some assets (particularly currencies), may have begun to price in an expected convergence in monetary policy.
Title graphic: Is eurozone and Japanese economic growth catching up to the U.S.?
The U.S. and the eurozone have both shown solid economic growth, lower unemployment rates, and slowly improving inflation. This has fueled concerns that the European Central Bank may start tightening monetary policy in the eurozone sooner rather than later.
Improving economic growth in Japan also has increased speculation that the Bank of Japan will tighten its monetary policy.
However, both the European Central Bank and Bank of Japan have been unwilling to tighten monetary policy to date, and have increased transparency to help manage expectations.

The European Central Bank has communicated that it expects to keep interest rates at current levels for an extended period of time after it ends its current asset-purchase program, while the Bank of Japan has suggested the central bank’s yield target will not be changed until next year.
Central bankers in the eurozone and Japan would like to see greater consistency in economic improvement before moving to tighter monetary policy. Additionally, inflation, while slowly rising, remains below the central banks’ targets.
Title graphic: Investor implications
We expect the European Central Bank to continue easing through the end of 2018 and to not start raising rates until 2019. Similarly, the Bank of Japan’s yield target is likely to remain unchanged for at least another year. Over the next year, we expect the Fed’s policy to continue to diverge from European Central Bank and Bank of Japan policy, both in terms of rates and balance sheet levels.
• We anticipate slight dollar weakness this year as investors balance the uncertainties surrounding monetary policy. We currently do not favor hedging international fixed income or equity holdings as we anticipate further dollar depreciation this year.
• We expect interest rate differentials to continue widening as U.S. short-term interest rates rise faster than those of eurozone and Japanese bonds. While we expect some additional return benefit from euro appreciation, we remain unfavorable on international developed-market bonds due to expectations for low yields.
• Global equity markets have benefited from easing measures taken by central banks globally, and international equities should continue to benefit from central-bank stimulus.
Risk Considerations
All investing involves risk including the possible loss of principal. Each asset class has its own risk and return characteristics which should be evaluated carefully before making any investment decision. Stock markets, especially foreign markets, are volatile. A stock’s value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. International investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets. Bonds are subject to interest rate, price and credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates.

General Disclosures
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