Advisors and the markets understandably have been focused on the Federal Reserve’s path to raising interest rates, with the first iteration occurring Dec. 16 and a consensus that several more hikes are likely in 2016. Such a focus may be understandable but overlooks how the world’s other central banks are dealing with monetary policy. As Jeffrey Kleintop warns, this myopia ignores the volatility “that may result as the widening divergence in monetary policy contributes to the challenges facing some markets.”
Kleintop, chief global investment strategist for Charles Schwab, points out in a Dec. 21 note that 20 central banks around the globe raised interest rates in 2015; those countries account for a third of global GDP. More central banks are expected to raise rates in 2016, he says — some compelled to do so since they peg their currency to the dollar. Others, like the Bank of England, will follow the Fed because they think, like the Fed, that their economies can handle “the less favorable financial conditions that come with higher interest rates,” and since their GDP growth rate is similar, unemployment has fallen to around 5% in both the U.S. and the U.K. and inflation remains tamed.
But while the global economy can handle higher rates — and will contribute to global GDP growth of close to 3.5%, Kleintop predicts — many individual countries will struggle with higher rates, and many central banks are still engaged in quantitative easing, such as the European Central Bank (ECB), the Bank of Japan and China.
As measured in their local currencies, European and Japanese stocks may perform relatively better next year, particularly since the financial sectors in Europe and Japan will be helped by further easing. However, Kleintop thinks that when combined with rate hikes in other countries, both the euro and the yen may well decline next year, which “may act as a drag on the return of unhedged investments by U.S. investors.”