You thought it was dead for good. So did I. It's a proven misfit in an ever-globalizing world. But the 'D' word is back. The U.S. economy is on the move, but Europe is stuck in the mud. Suddenly, there's lots of talk -- once again -- about decoupling. Plot the indicators, and they are compelling. Could the forecasters be right this time? And if so, is monetary policy likely to take opposing paths within these two economic behemoths?
This verbal battle is a dangerous one. It resurfaced in early 2008, just weeks after the Fed began an aggressive spate of rate-cutting. Convinced that Europe had decoupled from the weakening of U.S. output, ECB President Trichet famously raised interest rates on July 9 -- at precisely the same moment as the EU started to sink into the global economic mire. What then followed was a dramatic about-face -- a sequence of rate cuts that from start to finish was almost twice the speed of U.S. rate movements. In the relatively short (and volatile) history of the ECB, it has consistently moved rates -- both upward and downward -- in sync with the U.S. Fed, but with a multi-month delay. In short, there's no recent evidence that demonstrates decoupling, in spite of the pronouncements.
Is today any different? Markets appear to think so. Consensus expectations hold that the U.S. Fed is likely to begin a rate-tightening cycle sometime in the first half of 2015, a view that has been steady now for a number of months. Recent developments have market-watchers in Europe convinced that the ECB is unlikely to move rates upward until early 2017. If so, it would be the longest lag between U.S. and EU moves since the creation in 1999 of the ECB, and it would sure look like some form of decoupling had indeed occurred. Although the weight of recent history begs to differ, could decoupling really be in the works? Are the rule-books about to be rewritten?
One look at GDP data gets a yes-vote. The U.S. suffered in the first quarter, but when the weather improved, the economy snapped back at an outsized 4.6 per cent annualized pace. In contrast, Italy sunk back into recession, Germany posted a negative quarter in the April-June period, and all France could say was that they were 'stable' -- at zero growth, literally teetering on the edge of recession. While shocking, what is puzzling about this nascent turn is the absence of a clear reason for it. And while sentiment can turn on a dime, surveys show that European consumers and businesses are still relatively upbeat. In addition, it's not as if Europe has a long way to drop; the elevator never got far from the ground floor; growth is in fact more likely than another economic dip.
Pundits seem to agree. As of September, the average forecast still held that growth through the remainder of this year will revive, enough to notch a 1.2 per cent gain next year. It doesn't sound like much compared with U.S. growth -- until it's compared with estimates of long-run potential growth. The OECD figures that the current rate for Europe is about 1.1 per cent; the U.S. rate is just over twice that. If so, spare capacity is getting used up in both zones, although admittedly it's tighter in the U.S. Thus far, forecasters have both economies growing in tandem. If so, then monetary policy should take a roughly similar path. The recent extraordinary measures announced by the ECB are sort of quasi-contingent tools -- almost as if the bank feels that ultimately they may not need to put them to full use.
Time will tell whether the two monetary powerhouses will head in opposite directions. Given the recent history of co-movement, it's hard to believe that this is the precedent-setting moment. And a limited list of reasons for divergence makes it even harder.
The bottom line? For all the damage it has done to the reputations of brilliant analysts and policymakers over the years, 'decoupling' is still in the economic vernacular. It's not likely to ever die a decent death, but unless the radical economic intertwining we have witnessed over the past quarter century can be undone, it is becoming less likely over time that this word will be anything other than a fleeting headline-grabber. Given the world's need for sustained growth, we can only hope so.