German elections surpass the Fed

Published 29.09.2017 22:04

The unexpected resignation of U.S. Federal Reserve (Fed) Vice Chair Stanley Fischer on Sept. 7, the representative of the eagle side, was indicative of the Fed's lingering uncertainty over whether to sustain plans regarding the contractionary monetary policy. Amid the uncertainty, Fischer chose to leave because of lingering disagreements. For this reason, it is unclear whether the Fed's Federal Open Market Committee (FOMC) meeting held Sept. 19-21 will result in a clear decision on not only the rise of interest rates but also the reduction of the Fed's balance sheet. The global markets experienced a shock when Fed Chair Janet Yellen told the media on Sept. 20 that beginning from the last quarter of 2017 and with $10 billion per month, increasing by $10 billion every quarter, the process will continue until they reach $50 billion in monthly balance reduction, going on to say that the drop in the balance will reach $3 trillion by the end of 2020. Market professionals have now begun to interpret Fischer's resignation as a stepping stone for Yellen to take further, bolder measures.

The surprise decision from the FOMC meeting carried the dollar index, which indicates the value of the dollar against six major currencies, from below 92 points to 92.5 points. However, it was below 92.2 points on Friday evening, Sept. 22. As a matter of fact, while euro-dollar parity moved below $1.19, it again returned to the level of $1.195. The markets were expecting a clearer downgrade in euro-dollar parity and a stronger recovery in terms of the dollar when the FOMC declared its clear-cut decision on the reduction of the balance. This effect expected by global market professionals came from not the Fed but the results of the general elections in Germany. Even though German Chancellor Angela Merkel won for the fourth time to become Germany's chancellor, the 9-point loss of votes for the Christian Democratic Party/Christian Social Union in Bavaria (CDU/CSU), the defeat of Martin Schulz's Social Democratic Party (SDP) with only a five-point loss and the entry of the far-right Alternative for Germany (AfD) into parliament, increasing its vote by 9 points, have created shock effects. The fact that the numbers needed to form a new government will now be more difficult to achieve and that a new generation's far-right, neo-Nazi party entered parliament have increased worries over the EU's future and its values.

Germany's elections and Draghi's choicesTo be honest, the results of Germany's elections did what the Fed's balance contraction decision could not do. And, on Sept. 25, the euro-dollar exchange rate diminished to under 1.185 from 1.195, and briefly to 1.172 on Sept. 27. Even though Merkel said that the new government should be formed by the Christmas holiday, the issue that really alarms the EU is with which dynamics the far-right succeeded to gain this level of increase in votes, despite the strengths in the German economy. The many worries triggered by the German elections surpassed those of the Fed. We will learn how the election results in Germany will affect the strategies of the European Central Bank (ECB) President Mario Draghi in October. If Draghi wants to continue the expansionary monetary policy for a while longer, amid efforts to support the Eurozone economies that have entered a positive recovery process and delayed the monetary contraction to mid-2018, we can see the movement in the $1.20-1.16 band for the euro-dollar parity to retreat toward $1.16 to $1.12. On the contrary, if Draghi believes that the Eurozone has started to heat up and that the risk of inflation is rising, then he might begin monetary contraction for the ECB, in which case, the $1.16 to $1.20 band would become more permanent.

Some international finance institutions, on the other hand, foresee the movement over the first half of 2018 of the euro-dollar parity to extend until $1.16 to $1.28, if the ECB begins interest rate hikes amid pressure from Germany in response to the delay in the Fed's decision to increase interest rates. However, it seems like Fed Chair Yellen will continue her hawkish messages of Sept. 20. Yellen, who spoke in Cleveland, Ohio at the 59th Regular Meeting of the National Association for Business Economics on Sept. 26, stated that it is ill-advised for the Fed to be on standby for the monetary policies until inflation reaches the level of 2 percent. Thus, she gave a very clear message that it would be erroneous to delay the interest rate hike. She asserted that she believes the low inflation situation is temporary and that inflation will again stabilize at the 2-percent level in the coming years. Furthermore, Yellen, who drew attention to the fact that the Fed should avoid a multi-step approach to the interest rate hike, added that the workforce market might overheat without the necessary increases in interest rates. Let's wait and see where the tete-a-tete steps of the Fed and the ECB, over the next six months, will put euro-dollar parity.

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