30 Oct 2019

Could 2020 bring both Fiscal AND Monetary Policy easing?

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The diminishing momentum in the rate of global economic growth has been the main point of discussion for strategists pondering the most appropriate balance of portfolios in recent months. In line with the majority of similar circumstances since the ending of the financial crisis, the Central Banks rode to the rescue by cutting interest rates and, in the case of the ECB, resumed its QE programme.  The US Fed has now gone five years since its last purchase via QE and has stopped short of any specific reference to resuming it, though mention has been made of the potential to “accelerate the timetable towards balance sheet expansion”. 
As many observers have noted, endeavouring to create additional demand solely by cutting interest rates has been likened to pushing on a piece of string.  Thus, while sovereign bonds are not a source of risk in terms of likely default, they are increasingly not a source of longer-term return as yields have sunk to microscopic levels; they will however potentially still perform less badly than equity markets in the event that global economic growth forecasts prove still to be optimistic or because Central Banks re-enter bond markets with even larger cheque-books to stave off a return to recession.
There is a definite loosening of fiscal policy across the G7, with five of the seven expected to enact a less austere tilt to policy next year.
A different source of stimulus to the global economy could come from politicians who might be able (or be persuaded by weakening domestic growth prospects or rising levels of populism) to loosen the purse strings of fiscal policy.  This is already visible in the tactics of President Trump and became apparent in the recent comments from the UK Chancellor of the Exchequer Sajid Javid in which he referred to “turning the page on austerity”. 
The chart below indicates that there is a definite loosening of fiscal policy across the G7, with five of the seven expected to enact a less austere tilt to policy next year.  Not only would that create either additional government spending, or tax cuts that might then be spent, but governments could reassure themselves that the cost of additional sovereign issuance would be negligible, given prevailing levels of bond yields.  Any such increase in supply, relative to present expectations, should be negative for the prices in bond markets, whilst providing reassurance to investors in risk assets that the dismal prospect of even lower global growth had been reduced.
Change in the fiscal stance in G7 countries
Change in the fiscal stance in G7 countries

Source: Barclays September 2019

Number of central banks
Number of central banks

Source: Barclays September 2019

Ordinarily a rational investor would therefore be reducing exposure to bonds to redeploy into risk assets, to benefit from such an outcome.  Timing such a switch however involves believing that politicians will grasp the nettle with sufficient enthusiasm that the path of economic growth is distinctly affected.
Just as negative interest rates were not covered in economic textbooks and Central Banks becoming the dominant owner of their own countries’ bonds would have been deemed a work of fiction by most economists of the past half-century, so investors today are struggling to find the optimal balance between risk and reward in unprecedented circumstances.
Adding to risk assets feels potentially the correct tactic, but perhaps more obvious is to reduce exposure to bonds and endeavour to find more rewarding, but still largely economically insensitive, assets.  Such thinking explains the recent popularity of both gold and infrastructure assets, as well as that of real estate with longer-dated leases.

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