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Divergence down, not out

KEY TAKEAWAY

Even small central bank action can meet with big market reaction. Against an uncertain backdrop, diversifying across countries and currencies makes sense.

Diverging central bank policy has been an important market theme for more than two years. The gist of it: A U.S. Fed poised to tighten monetary policy has sat opposite other global central banks in full easing mode, toiling to bolster their flagging economies. This divergence drove a strengthening U.S. dollar and greater disparity among government bond yields around the world.

DIVERGENCE HAS BEEN A DRIVER SINCE 2014
Two-Year Government Bond Yields, 2013–2016

Graph: Divergence has been a driver since 2014
Sources: BlackRock Investment Institute and Thomson Reuters, as of June 2016. Notes: QE stands for quantitative easing. BoJ stands for the Bank of Japan. ECB stands for the European Central Bank.

That monetary policy gap has closed somewhat. The Fed is expected to increase rates slowly, and Japan and Europe have limited room to lower their already-negative rates. The reality is that many of the forces restraining growth and suppressing yields internationally are present in the U.S. as well, bringing policies around the world closer.

ON PAUSE FOR NOW, BUT NOT FOREVER
Policy Stance of 75 Largest Economies’ Central Banks

Graph: On pause for now, but not forever
Source: BlackRock, as of June 2016.

That monetary policy gap has closed somewhat. The Fed is expected to increase rates slowly, and Japan and Europe have limited room to lower their already-negative rates. The reality is that many of the forces restraining growth and suppressing yields internationally are present in the U.S. as well, bringing policy closer.

We expect divergence could re-emerge late this year as the Fed weighs incoming economic data versus global risks. Meanwhile, less divergence is keeping a lid on the U.S. dollar, which supports the case for diversifying portfolios across countries and currencies.

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