Fed and ECB Bend to Markets Ahead of Economy

Fearing market disruptions, both the European Central Bank and the Federal Reserve will most likely take more stimulus measures this month regardless of what their analyses tell them about the potential impact on the economy and financial assets. That has implications for both future economic prosperity and medium-term financial stability, and it adds to the to-do list for policy makers and investors.

Markets expect central banks — not just in advanced economies but also in emerging markets — to go on a loosening tear, cutting more than 1,000 basis points in interest rates worldwide over the next year. Markets have already baked this in for the ECB and the Fed so heavily that a material failure by them to validate such expectations would most likely lead to a spike in volatility in financial markets, which are already nervous because of the deteriorating global economic outlook. Hoping to keep the risk of such volatility from undermining household and corporate sentiment, these two central banks will feel compelled to loosen monetary policy further, first on Sept. 12, with the ECB cutting its rates further into negative territory and resuming asset purchases, and then on Sept. 18, with the Fed cutting interest rates again.