- And why the Fed matters more. Though European Central Bank President Mario Draghi heightened expectations for even more monetary support for Europe’s beleaguered economies, the upcoming shift in the Fed's monetary policy matters more. In Europe, the path from potential QE to the real economy flows through the currency, and already with some success. But the greater the impact of QE on the currency, the less the impact on dollar asset prices.
- Exorbitant privilege. The dollar is the world's reserve currency, what the French called the U.S.' "exorbitant privilege". Increasing economic divergence between a strengthening U.S. and a weakening Europe led to both a widening gap in U.S. vs. European interest rates and a declining euro. Because global debt outstanding, global trade, global reserves and global currencies are predominately dollar based (facts indicative of reserve currency status), the upcoming shift in U.S. monetary policy expectations holds greater impact for the outlook for financial markets than any potential ECB program of broad-based Quantitative Easing.
- A Rising Tide…may lift all boats, but a rising dollar sinks oil and gold. Recent declines in oil and gold reflect a stronger dollar, which in turn reflects heightened expectations of Fed policy normalization. Leaving the era of zero rates behind undermines the attraction of gold. Falling oil prices reduces the re-cycling of petrodollars back into U.S. Treasuries, reducing that source of support for low yields. Declining oil prices also function like a tax cut for U.S. consumers, bolstering disposable income and increasing the outlook for consumption and U.S. growth. That can further undermine expectations for continued zero interest rate policy and potentially shift both the pace and terminal rate of monetary policy, leading to higher interest rates in the U.S.