The better-than-expected U.S. nonfarm payrolls data, as well as the strong wage growth figure, point toward an interest rate hike by the Fed in December, delivering some certainty about the future path of rates.
The euro fell sharply vs. the dollar after the news, trading 1.4% weaker on the session, as the data made clear that the divergence between the world's two biggest central banks will accentuate at the end of the year.
Expect the European Central Bank (ECB) to steal the show from the Fed in December, because it is likely to deliver some quite impressive monetary easing measures. ECB President Mario Draghi has been trying to push the euro's exchange rate lower by acting in two stages: first, by signaling an easing stance with a very dovish speech last month, and second... well, it remains to be seen in December, but all the data point to a need for the ECB to do more.
The most recent data out of Europe were the European Commission's Autumn Forecasts, and they show that growth in the eurozone is likely to be 1.8% next year and 1.9% in 2017, while inflation is expected to remain well below the ECB's target at 1% and 1.6% respectively. This points to ample room for the ECB to push rates deeper into negative territory, increase its bond purchases, announce it extends its quantitative program beyond September of 2016, or all three.
It would also mean a return to the 1990s. Analysts at Bank of America Merrill Lynch note that if Europe and the United States diverge in monetary policy, it would be for the first time since May 1994 that America has a rate hike while Europe has a rate cut.
The credit cycle in Europe is also likely to lag the one in the America, where, "after a five-year credit binge, earnings for high-yield issuers have more or less stalled, leverage is rising and investor risk appetite is waning," the analysts note. This will mean more defaults in the United States than in Europe where the credit cycle is still young, and this pattern could last at least a couple of years.
What are investors to do? Well, capital flows have shown from the beginning of the year that money has been heading towards European equities, which have taken in funds even when other asset classes were suffering.
Looking at the eurozone countries, good news finally came out of Italy ¿ the ECB's policy is helping it so much that yields on Italian two-year bonds were negative ¿ while Spain is also recovering quite well, albeit at a slower pace than before and has elections next month. These two countries may be a good bet for those looking to gain exposure to the eurozone's money-printing machine.
By contrast, the single currency area's engine of growth seems to be stalling. Germany's latest industrial production data disappointed, hot on the heels of the Volkswagen (VLKAY) scandal.
Another area where monetary policy is likely to remain easier than in the United States is the United Kingdom, where Bank of England Gov. Mark Carney delivered surprisingly dovish signals yesterday just as the market had penciled in a rate rise this year. Expectations for U.K. rate increases have been pushed to next year, but this did not cheer up investors because it shows the central bank does not have a clear plan to stay ahead of the curve.
In short: If you want interest rate differential and weak currencies, go to Europe. But if you want real growth, invest in the United States ¿ the world's biggest economy looks like it's the strongest as well. At least, strong enough to withstand the first interest rate hike since the Great Recession.