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Last week, the Federal Reserve ended its nearly decade-long era of keeping interest rates near zero.
The week prior to that, the European Central Bank committed itself to further its stimulus programs.
December has been a big month for monetary policy decisions. How do the European and U.S. monetary policies compare? And which plan will provide the best investment opportunities for you?
ECB Commits to Fostering Growth
At the beginning of the month, Mario Draghi, president of the European Central Bank, announced the ECB would cut interest rates in an effort to boost Europe’s sluggish economy. However, the market slid as investors were disappointed that the ECB did not take more dramatic measures.
Its deposit rate went even further into negative territory. This ongoing policy of negative interest rates means the ECB essentially charges banks for holding money with them. Going further into negative territory means that banks are being charged even more.
Among the announcements, the ECB committed to continue buying government bonds and other assets until March 2017. This is six months longer than its original plan, but this announcement wasn’t enough to meet investor expectations.
The ECB also announced it would continue these purchases at a rate of 60 billion euros a month. Investors had expected the ECB to say it would increase its bond buying program to at least 10 billion euros a month.
After markets fell sharply upon the announcement, Mario Draghi rushed in to reassert that the ECB was committed to stimulating the European economy at all costs.
US and European Policies Diverge
The Fed’s most recent announcement went in the opposite direction of the rest of the world, where banks continue to fuel growth by adding liquidity into the market.
Last Wednesday, the U.S. Federal Reserve raised interest rates for the first time in nearly a decade. The chairwoman of the Fed’s Board of Governors, Janet Yellen, said Thursday that the central bank was increasing rates by 0.25%.
The Dollar Dominates
As interest rates climb higher in the U.S., the dollar will strengthen. This is great if you are going on vacation. For U.S. businesses that export, this is awful.
Companies that are looking for growth by exporting abroad are going to falter, while their European competitors can slip into the U.S. markets at lower prices.
Look to Europe for Higher Total Returns
While the U.S. promises more investment security and a stronger currency, Europe and European equities should offer the total higher returns in 2016. Spurred by the continuing quantitative easing policies, Europe should see the higher returns.
J.P. Morgan has said that it believes that Europe is going to grow an excessive 1%. This would translate into 10% earning growth over 2016 in the eurozone.
However, consider hedging against the currency risk. Invest in a fund that is going to hedge against the exchange risk as the dollar continues to gain against the euro. This way you can get the benefit from the growth in Europe without losing as the euro falls against the dollar.
The largest European equity ETF is Vanguard FTSE Europe ETF (NYSEArca: VGK). It is the easiest (and cheapest) way to get a broad exposure to European equities. The expense ratio is a tiny 0.12%, 90% lower than the average expense ratio of similar funds.
How to Sleep Easy at Night
Is the economy keeping you up at night? Do you worry there’s another crash just around the corner? If so, you can stop worrying right now. All it takes is a few minutes.