Diverging central bank policy has been a well-televised theme in 2015, and in mid-December, divergence may finally begin. This week, the European Central Bank may ease monetary policy further in an effort to stimulate inflation expectations across the European economy, and two weeks later, the Federal Reserve is expected to raise the federal funds rate. Though the expectation of these policy moves is fairly consensus, the financial impact is largely unknown. For example, rising short-term rates in the U.S. and lower rates in Europe should, in theory, lead to dollar appreciation. However, the expected difference in interest rates may already be priced in. Turning to long rates, the impact of diverging monetary policies is more apparent. This week’s chart shows the positive correlation between 10-year government bond yields in Germany and the U.S., which suggests that low rates in Europe will likely anchor long rates in the U.S. While U.S. government bonds may face some headwinds, even from a gradual increase in rates, the more credit-sensitive sectors of the bond market may not feel this same pain. In fact, slowly rising interest rates are a navigable headwind for credit, as this has historically led to tighter spreads, rather than higher yields, and is therefore less pain for investors in this space.
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