One of the biggest surprises of 2017 was the fact that the euro exchange rate measured against the U.S. dollar appreciated 14%—only about 7% behind the performance of the S&P 500 Index over the same period.1
The Consequence: European Equities Look Quite Attractive (7/31/12–4/30/2018)
This spread illustrates one consequence of a central bank policy divergence, as the 10-year German bund was around .60%, approximately one-fifth of the 2.95% where we saw the U.S. 10-Year. Yes, the current earnings yield of the WisdomTree Europe Hedged Equity Index is about 190 basis points higher than that of the S&P 500 Index, but an even greater reason for the difference in spread is the very low position of German interest rates.
Our European equity Index is focused on export-oriented companies that derive more than 50% of their revenues from outside of Europe. The euro's performance is important, therefore, in that, a weaker euro creates a stronger fundamental backdrop for the earnings of these companies.
Interest Rates Matter
Central bank policy divergence has been one of those “big themes” often discussed among market participants around the world, and along those lines, many would then cite the policy rates first because these are what the central banks directly influence.
However, it is also important to look further out on the interest rate curve. Ten-year government bond interest rate differences between Germany and the U.S. indicate a broader spectrum of differences beyond central bank policy and could indicate both growth and inflation differentials.
Difference in Central Bank Policy Rates: U.S. federal reserve Minus European Central Bank (ECB)
Difference in U.S. 10-Year Treasury Interest Rate Minus 10-Year German Bund Interest Rate
Policy Rates: It is very clear that the U.S. central bank has tended toward a higher policy rate than the ECB over the vast majority of the period that we can analyze. The difference peaked—meaning the Fed policy reached its highest level in a relative sense—in 2000 and in 2006. The critical question is whether we are traveling toward a third peak, being currently at about a 2% difference, around half of the historical maximum in the 4% range.
